Proposed changes to the “Residency Test” in the Takeover Code, the net widens…

November 26, 2012

 

The code committee of the UK Panel on Takeovers and Mergers (the Panel) issued a consultation paper setting out proposals to remove the residency test, which is used to determine whether traded companies on non regulated markets are within the jurisdiction of the Takeover Code (the Code). 
What is the Residency Test?
The Code applies to companies listed on a UK regulated market (i.e. principally the Main Market of London Stock Exchange) whose registered offices are in the United Kingdom, the Channel Islands or the Isle of Man (the Relevant Territories). 
The Code also applies to companies whose registered offices are in the Relevant Territories and whose securities are admitted to trading on a non regulated market in the United Kingdom (for example on AIM, or on a stock exchange in the Channel Islands or the Isle of Man) if the relevant company is considered by the Panel to have its place of central management and control in one of the Relevant Territories.
To determine where a company has its place of central management and control, the Panel looks at whether a majority of the directors are resident in one of the Relevant Territories and if they are, the test will normally be satisfied.  Where there is an even split, the Panel will typically have regard to the place of residence of the Chairman of the company.  Under the existing regime of the residency test it can be difficult for a potential offeror or other external third parties to determine where the board of an AIM company resides – which can present practical difficulties when seeking to determine the application of the Code in the context of actual or proposed transactions.  The Panel will typically have to make enquiries of the company in question in order to verify the residency of its directors (and, therefore, the applicability of the Code), and this is sometimes not in the potential offeror's interests nor that of potential investors.
Impact of the abolition of the Residency Test
The Panel’s proposed removal of the ‘residency test’ will mean all AIM-listed companies incorporated in one of the Relevant Territories will be subject to the Code, irrespective of their place of central management and control. This would effectively bring AIM in line with the Main Market (the residency test was removed for main market companies when the Takeovers Directive was implemented in the UK) and shareholders will be protected by the Code with the obvious merit being that the Code’s General Principles and Rules provide that shareholders in a company subject to a takeover offer must be treated fairly and must not be denied the opportunity to decide on the merits of the bid. 
The significance of becoming subject to the Code will of course depend on shareholder profile.  Unlike the Main Market, which requires a minimum of 25 per cent. of a company’s shares to be in public hands, AIM has no free float requirement.  It is not uncommon for the controller of an AIM-listed company to have a percentage shareholding greater than 50 per cent.  For such companies, the impact of the Panel’s proposed changes would be minor.  For an AIM-listed company under the effective control of a shareholder group with a shareholding up to 50 per cent, the impact could be significant, as these shareholdings could not be increased above 30 per cent., or between 30-50 per cent. without a mandatory offer being made or Panel waiver and shareholder consent obtained, this may in the long run impact the attractiveness of listing on AIM. 
A large number of AIM companies incorporated in the Relevant Territories, particularly in the natural resources sector, are managed overseas. These companies are not currently subject to the Code though in many cases have provisions in their constitutions which seek to replicate the mandatory takeover protections of the Code. Such provisions typically afford directors significant discretion as to when and how the Code-like protections are enforced. If the proposed changes are implemented, directors would lose this element of discretion, however this will bring certainty to shareholders as they will receive the protection of the Code which is in line with the expectation that a company whose registered office is in one of the Relevant Territories will benefit from Code protection. 
What’s next 
Companies affected by the proposed abolition of the residency requirement should seek advice on how the proposed changes may affect them, from issues relating to control and corporate transactions to smaller housekeeping matters – such as amending their articles of association when appropriate. Companies registered in the Relevant Territories may prefer to remain outside the scope of the Code and a restructuring would be required in order to relocate - this may be achieved via a scheme of arrangement putting in place a new holding company incorporated in the new jurisdiction of choice – though it remains to be seen whether minority shareholders would tolerate such a move. Companies thinking of listing on AIM may choose to incorporate in a chosen jurisdiction outside of the Code. 
The proposals are generally welcomed given there has been a great deal of uncertainty and confusion which will be removed. Directors and investors will need to be aware of the practical implications outlined above especially where the AIM company is effectively controlled by a shareholder group of between 30 and 50 per cent. 
The consultation period on the proposed removal of the residency test ended on 28 September 2012 and the Panel is expected to publish a response statement by early 2013 so watch this space.

The code committee of the UK Panel on Takeovers and Mergers (the Panel) issued a consultation paper setting out proposals to remove the residency test, which is used to determine whether traded companies on non regulated markets are within the jurisdiction of the Takeover Code (the Code). 

What is the Residency Test?

The Code applies to companies listed on a UK regulated market (i.e. principally the Main Market of London Stock Exchange) whose registered offices are in the United Kingdom, the Channel Islands or the Isle of Man (the Relevant Territories). 

The Code also applies to companies whose registered offices are in the Relevant Territories and whose securities are admitted to trading on a non regulated market in the United Kingdom (for example on AIM, or on a stock exchange in the Channel Islands or the Isle of Man) if the relevant company is considered by the Panel to have its place of central management and control in one of the Relevant Territories.

To determine where a company has its place of central management and control, the Panel looks at whether a majority of the directors are resident in one of the Relevant Territories and if they are, the test will normally be satisfied.  Where there is an even split, the Panel will typically have regard to the place of residence of the Chairman of the company.  Under the existing regime of the residency test it can be difficult for a potential offeror or other external third parties to determine where the board of an AIM company resides – which can present practical difficulties when seeking to determine the application of the Code in the context of actual or proposed transactions.  The Panel will typically have to make enquiries of the company in question in order to verify the residency of its directors (and, therefore, the applicability of the Code), and this is sometimes not in the potential offeror's interests nor that of potential investors.

Impact of the abolition of the Residency Test

The Panel’s proposed removal of the ‘residency test’ will mean all AIM-listed companies incorporated in one of the Relevant Territories will be subject to the Code, irrespective of their place of central management and control. This would effectively bring AIM in line with the Main Market (the residency test was removed for main market companies when the Takeovers Directive was implemented in the UK) and shareholders will be protected by the Code with the obvious merit being that the Code’s General Principles and Rules provide that shareholders in a company subject to a takeover offer must be treated fairly and must not be denied the opportunity to decide on the merits of the bid. 

The significance of becoming subject to the Code will of course depend on shareholder profile.  Unlike the Main Market, which requires a minimum of 25 per cent. of a company’s shares to be in public hands, AIM has no free float requirement.  It is not uncommon for the controller of an AIM-listed company to have a percentage shareholding greater than 50 per cent.  For such companies, the impact of the Panel’s proposed changes would be minor.  For an AIM-listed company under the effective control of a shareholder group with a shareholding up to 50 per cent, the impact could be significant, as these shareholdings could not be increased above 30 per cent., or between 30-50 per cent. without a mandatory offer being made or Panel waiver and shareholder consent obtained, this may in the long run impact the attractiveness of listing on AIM. 

A large number of AIM companies incorporated in the Relevant Territories, particularly in the natural resources sector, are managed overseas. These companies are not currently subject to the Code though in many cases have provisions in their constitutions which seek to replicate the mandatory takeover protections of the Code. Such provisions typically afford directors significant discretion as to when and how the Code-like protections are enforced. If the proposed changes are implemented, directors would lose this element of discretion, however this will bring certainty to shareholders as they will receive the protection of the Code which is in line with the expectation that a company whose registered office is in one of the Relevant Territories will benefit from Code protection. 

What’s next 

Companies affected by the proposed abolition of the residency requirement should seek advice on how the proposed changes may affect them, from issues relating to control and corporate transactions to smaller housekeeping matters – such as amending their articles of association when appropriate. Companies registered in the Relevant Territories may prefer to remain outside the scope of the Code and a restructuring would be required in order to relocate - this may be achieved via a scheme of arrangement putting in place a new holding company incorporated in the new jurisdiction of choice – though it remains to be seen whether minority shareholders would tolerate such a move. Companies thinking of listing on AIM may choose to incorporate in a chosen jurisdiction outside of the Code. 

The proposals are generally welcomed given there has been a great deal of uncertainty and confusion which will be removed. Directors and investors will need to be aware of the practical implications outlined above especially where the AIM company is effectively controlled by a shareholder group of between 30 and 50 per cent. 

The consultation period on the proposed removal of the residency test ended on 28 September 2012 and the Panel is expected to publish a response statement by early 2013 so watch this space.

 


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