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.
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 AIM 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.
The diagram below represents a "decision tree" for an AIM 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.
Different fundraising structures will have different requirements; some considerations are set out below.
1 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).
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 generally be necessary. 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.
The duty to disclose inside information to the market, both under the AIM Rules and the Market Abuse Regulation 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". It may therefore be possible to delay disclosure of financial distress provided there is a realistic prospect of finalising in short order negotiations with a view to ensuring the financial recovery of the issuer.
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.
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.
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.
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.
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.
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.
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.
