'Share-splitting' in Schemes of Arrangement: Judgment in the Dee Valley Case

In doing so, the Court has given its first ruling on the validity of 'share-splitting' in the context of a scheme of arrangement. This issue is relevant because a scheme requires the approval of the majority in number of voting shareholders, and in this case shares in the target had been distributed to a large group of individuals who opposed the scheme.

The only previously reported case was in the Hong Kong Court of Appeal (Re PCCW Ltd [2009] HKCA 178) which, in effect, ruled at a scheme's sanction hearing against share-splitting, in circumstances where the scheme was approved by scheme shareholders at the Court convened meeting (the "Court Meeting") and the 'split' shares had voted in favour of the scheme. In the Dee Valley case, the 'split' shares were voted against the scheme, with a view to preventing the scheme from reaching the sanction hearing and being subject to any further deliberation.

Travers Smith has been advising Dee Valley Group.

Background

Dee Valley Group plc is a water company operating in North East Wales and the North West of England. At the time of the Court Meeting, and the subsequent sanction hearing, it was the subject of two competing takeover bids, by Severn Trent Water Limited ("Severn Trent") and by Ancala Fornia Limited ("Ancala"). The latter, lower bid is structured as a contractual offer. The sanction hearing in question related to the proposed scheme with Severn Trent, being the higher recommended bid.

An employee of Dee Valley who was opposed to Severn Trent's bid had acquired approximately 460 shares in Dee Valley a few days before the record date for the Court Meeting, and had gifted most of those shares to around 440 other persons (the 'Opposing Shareholders').

The votes of the Opposing Shareholders (which were all cast against the scheme), if valid, would have defeated the scheme, as approval was required from a majority in number, representing 75 per cent in value, of members voting at the Court Meeting.

Commentators have previously speculated that the Court would have no jurisdiction to sanction a scheme which failed to obtain the statutory majorities at the Court Meeting – suggesting that the legislation itself would need to be changed to prevent such behaviour being able to block a scheme.

Dee Valley sought a ruling on the legitimacy of the votes subject to the share-splitting. Accordingly, at an ex parte hearing sought by Dee Valley and held before the Court Registrar two days before the Court Meeting, the Registrar gave a direction that the Chairman of the Court Meeting could disregard the votes of the Opposing Shareholders, with the specific intention of preserving all parties' arguments until the sanction hearing. At that sanction hearing all interested parties would have the opportunity to make representations. By virtue (only) of those votes being disregarded, the majority thresholds were passed at the Court Meeting, and accordingly the matter of the share-splitting could be reviewed at the sanction hearing.

At the sanction hearing, representations were heard from (i) Severn Trent and an existing shareholder, arguing that the scheme should be sanctioned and (ii) the Opposing Shareholders and Ancala, arguing that it should not.

The court's decision

Sir Geoffrey Vos, the Chancellor of the High Court, sanctioned the scheme on the basis that the chairman of the meeting had acted properly in rejecting the votes of the Opposing Shareholders, and there was no basis upon which the Court should exercise its discretion not to sanction the scheme.

In the circumstances, he held that the actions of the Opposing Shareholders demonstrated that they could have given no consideration to the interests of the class of members which they had joined: the only possible explanation for their conduct was to further a strategy to defeat the majority in number requirement. It was therefore ruled that the Chairman was entitled to protect the integrity of the Court Meeting against "manipulative practices such as share-splitting".

With regard to the question of whether the Court would have had jurisdiction to sanction the scheme if the Chairman had wrongly rejected the votes, the Court held that this question need not be decided in this case, but expressed agreement with the view that it would not have had jurisdiction to sanction a scheme in such circumstances.

We await the decision of the Opposing Shareholders as to whether to appeal the High Court's decision.

Implications

•  This was an important judgment as, if the scheme had not been sanctioned, schemes may have been rendered less attractive, given the risk of share-splitting.
• Share-splitting has long been considered a theoretical possibility but today's judgment confirms that artificially boosting the number of voting shareholders is, in certain circumstances, objectionable.
• In this case, the Court was clear that the Opposing Shareholders were not voting for the purpose of benefitting the class as a whole. Where the motives of opposing shareholders (and perhaps the timing of their actions) are less obvious, courts will be reluctant to interrogate their reasons for voting against a scheme.
• In any event, the ruling reinforces the need for vigilance as to movements on share registers when planning or executing bids by way of a scheme.

Notes

Travers Smith is advising Dee Valley Group plc in connection with the offers by Severn Trent and Ancala, and in relation to the matters raised by the "share-splitting". Counsel acting for Dee Valley Group plc is Andrew Thornton of Erskine Chambers.