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Companies (Mergers And Divisions) Regulations 1987

Volume 489: debated on Thursday 29 October 1987

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7.45 p.m.

rose to move, That the draft regulations laid before the House on 9th April, be approved. [20th Report from the Joint Committee, Session 1986–87.]

The noble Lord said: My Lords, the Companies (Mergers and Divisions) Regulations, made under the European Communities Act 1972, have as their sole purpose to implement the Community's third and sixth company law directives in Great Britain. Rules similar to these regulations will be made later this year to implement the directives in Northern Ireland.

Neither the directives nor these regulations contain any provisions affecting competition policy. The third directive, adopted in 1978, deals with the operation under which two or more public limited companies (plcs) are merged by the transfer of all the assets and liabilities of one or more plcs to another plc or to a new company. In exchange, the shareholders of the transferring companies receive shares in the recipient company. The directive does not deal with takeovers where all that happens is that one company acquires the shares in another company. The sixth directive, adopted in 1982, deals with the reverse process to a merger; namely, where a plc is divided and all its assets and liabilities are transferred to two or more plcs or to new companies formed for the purpose of the operation in exchange for the allocation to the shareholders of the plc being divided of shares in the recipient companies. The philosophy underlying these directives is to provide broadly equivalent safeguards in member states for members and creditors of public limited companies which are a party to such operations.

I should explain to your Lordships that the types of operation covered by both directive occur very infrequently in this country. Mergers of the type covered by the third directive are far less common than takeovers. Moreover, so far there has been no division of a public limited company in this country of the kind dealt with in the sixth directive. Therefore, the impact of these regulations on the commercial life of this country is very limited.

The deadline for implementing the third directive was originally set as October 1981. However, because work was still proceeding on the very closely related sixth directive, member states were not in practice held to the original deadline for implementing the third directive and it was eventually agreed that member states would be permitted to implement the third and sixth directives together by the date described for the latter, that is 1st January 1986. Unfortunately because of discussions arising from the consultations we undertook in the autumn of 1985 and last year (including with the Commission) we have overrun the deadline. However, I understand several other member states have yet to implement either directive so we are by no means the last to do so.

Both directives contain detailed provisions about the information which shareholders are to receive and about the protection for creditors of the plcs involved in these operations, in particular: first, the drawing up by the directors of all the plcs involved of written draft terms of division or merger as the case may be, including descriptions of the assets and liabilities to he transferred, their allocation amongst the recipient companies and the criteria for the allocation of shares in the recipient companies among the shareholders of the transferor companies; secondly, publication of the draft terms of a merger or division at least one month before they are to be considered by a general meeting of each of the plcs involved; thirdly, a report by the directors of each company involved, explaining the draft terms of the merger or division; fourthly, a report by an independent expert on the draft terms of the merger or division; fifthly, approval by the general meeting of each plc involved; and, lastly, the laws of member states must provide for an adequate system of protection of the interests of creditors of the merging or dividing companies whose claims antedate the publication of the draft terms of merger or division.

The current law in this country in these matters is set out in Sections 425 to 427 of the Companies Act 1985 dealing with arrangements and reconstructions. The procedures which have in practice been followed in this country by companies seeking to effect a merger of the type described in the Third Directive have had some similarities to those prescribed in these regulations, although they have not previously been set out in statute.

Your Lordships may recall that the Sixth Directive gave rise to some discussion in the period 1980–1982 when it was being negotiated. As originally drafted, it was criticised as unnecessary and, moreover, more rigid and therefore less flexible in its approach than the existing provisions of the Companies Act. Following consultations with representative organisations in this country the United Kingdom negotiating team drew attention in Brussels to the criticisms that were made of the directive. A majority of member states and of the Commission nevertheless remained firm in their view that it was right that the Community should adopt a directive to deal with divisions, but in these negotiations changes were made to the original proposal which will allow us to retain elements of the United Kingdom system of judicial supervision of mergers and divisions. I should record that the views on the proposed Sixth Directive put forward by the House of Lords Select Committee on the European Communities and by the House of Commons Select Committee on European Legislation were especially valuable to us in the course of the negotiations.

The general approach of the regulations is to make no change to Sections 425 to 427 of the Companies Act 1985. However, they enact a new Section 427A and Schedule 15A and they provide that, where there is a merger or division of the kind dealt with in the directive, that operation will be subject to the modifications and additional provisions there set out. Sections 425 to 427 will continue to apply unamended to other operations. The new provisions will cover a merger of two or more pies even if there are other companies involved which are private. The directives do not, however, apply to the private companies themselves and neither will these regulations. On divisions, the company being divided must be a plc and the transferee companies must be either a plc or a new company (whether or not a public company) formed for the purpose of the division.

It has been argued that the directives should also be applied to mergers and divisions where private companies and only one public limited company are involved. We believe however that the existing provisions of the Companies Act already cater adequately for the interests of those concerned with such companies. Therefore, the approach we have adopted goes no further than we think we have to go in order to meet our Community obligations. On this basis the shareholders of pies would not be deprived of the protection afforded to them by the directive even in those situations where a merger includes private as well as two public companies.

As your Lordships may know, certain mergers or divisions involving the transfer of the business of a life insurance company cannot be carried out under Sections 425 to 427 of the Companies Act 1985, but must be undertaken in accordance with special provisions of the Insurance Companies Act 1982. Further regulations will be presented shortly to deal with our obligations under these directives in respect of those insurance companies. I ask your Lordships to approve these regulations. I beg to move.

Moved, that the draft regulations laid before the House on 9th April, be approved. [ 20th Report from the Joint Committee, Session 1986–87.]—( Lord Beaverbrook.)

My Lords, the House will be grateful to the noble Lord, Lord Beaverbrook, for explaining the provisions contained in this draft statutory instrument. I shall try to focus on some of the major issues first and then ask the noble Lord if he would reply to a series of what I shall call clarificatory questions that I have.

I hope I misheard the noble Lord when he seemed to say that the provisions of schemes of arrangement and the amendments proposed to the Companies Act under this draft order did not form—I cannot remember the expression—an important part of our commercial life. Schemes of arrangement, as I know them, and indeed going back to the old Companies Act 1948, have formed a very important part of our commercial life.

I agree that divisions have not so far formed a part of our commercial life simply because it is rather difficult to achieve. but schemes of arrangement—the old Section 206, if my memory serves me right, or Section 209—were a very important part, and that carried through into the sections of the consolidated Act of 1985 to which the noble Lord referred: Sections 425 to 427. Anything that affects ability to enter into schemes of arrangement as we have known them in the past must be of some concern to our commercial life.

My second general point is that I appreciate that under the European Communities Act 1972—specifically under paragraph 2(2) of Schedule 2—the wires for this draft order is clearly established. Nevertheless I find it curious that I can hold up in my hand a Companies Act which was consolidated in 1985 and is as thick—and I demonstrate to your Lordships—as that, and that we have amendments to this Companies Act produced by orders under a different piece of legislation which properly, if there were no European Communities Act, because of the size and complexity of this order, would form a new Companies Bill. It is difficult for practitioners to operate with an Act even as complicated as the Companies Act 1985 if this Act is going to be amended on a regular basis under orders made under a different Act.

This leads me to my third point. What will the effect in practice be on the commercial and financial life of our country if this draft order goes through in its present form? The draft order deals, as the noble Lord rightly pointed out, with mergers and divisions. I do not intend to spend any time at all discussing the questions of divisions, for the reasons that I have already mentioned. As the noble Lord pointed out, these are relatively unimportant, although I recognised that there is a directive which refers particularly to them and we have to assent to it.

The problem that I see with this order in its draft form is that it introduces a number of elements into mergers by way of what I shall continue, I am afraid, to call schemes of arrangement, which we are not used to and which are not customary, and indeed which create certain problems for the practitioners in the market who now perform certain roles which are changed by this order.

My main point under this heading is the question of the expert's report. Up to now, as your Lordships will know, when there is a merger, be it a scheme of arrangement or anything else, it is quite normal to have a circular sent to shareholders which contains a recommendation from a merchant bank, or two merchant banks, or sometimes three merchant banks. Indeed investors rely very much on the recommendations made by those merchant banks.

We are now told in this order that if there is a scheme of arrangement the merchant banking opinion—whatever that may be of course is not mentioned in the order—does not matter at all; that what matters is the thing called the expert's report. The expert is none other than somebody who is qualified to be an auditor and is therefore an accountant. So we shall have what I regard as an absurd situation.

Current practice and the shareholders will demand that merchant bank X, which is advising company Y. and merchant bank A, which is advising company B, both make recommendations to the effect that having studied all the facts of the case, they believe they can recommend that the merger go ahead as a scheme. Then an expert's report by an independent accountant has to be produced for the court. That report will state, "We think that merchant bank A or merchant bank B may be wrong". It may be right or wrong, but there is no point in the expert simply endorsing the statement of the merchant bank. Otherwise, why have an expert's report in the first place?

If the expert, who is an accountant, disagrees with the recommendation of the merchant bank, the accountant in question (whoever he or she may be) cannot expect a great deal of business from the merchant banks with which he disagrees on a recommendation for a merger of this nature. I am afraid that those are the commercial facts of life and we must attend to them.

The expert's report accompanies the directors' report. The directors' report, as set out in the proposed Schedule 15A, will consist of a number of statements including one "specifying any special valuation difficulties". I am glad to see the noble Lord, Lord Kissin, sitting on the Cross-Benches because he and I have engaged in many transactions in which there have been valuation difficulties. At the end of the day if there is a willing buyer and a willing seller, one comes to some sort of compromise. I would argue that almost every deal has valuation difficulties in principle and that one cannot specify any particular item. The directors would be quite wrong to specify any particular item which has given rise to special valuation difficulties. Anybody who has any experience of such deals knows that one takes the whole package and says, "I'll trade you my head office, and you trade me your distribution network". That is how one reaches a global price or a global exchange of shares and a global ratio on which one can deal.

The problem is compounded when one reads that the expert has to comment on what the directors have specified as valuation difficulties. He has to describe them and state whether in his opinion the share exchange ratio is reasonable. That is exactly what merchant banks do at the moment.

Should it be the case that Price Waterhouse, Coopers and Lybrand or Peat, Marwick, Mitchell and so on—to take names at random—have to decide, comment and opine on whether a merchant bank recommended merger or scheme is reasonable, I am afraid I must tell the noble Lord that it will upset the balance of advisory forces that are at present in operation in the City of London.

There are some points of particular interest on which I ask for clarification. In the order as drafted, new Section 427A specifies that this clause only bites if the consideration is to be shares. It may be with or without any cash payment but the essence of it is that there should be shares. In normal commercial parlance the word "shares" covers a multitude of things. For instance, does the clause bite if the consideration is cash plus a few preferred shares—not ordinary shares but preferred shares? Does it bite if the consideration is cash plus one or two of the non-special something or other convertible shares. Or does it bite where there is a convertible debenture—a debenture convertible into shares? Does it bite if there are parts of the consideration which are in shares of companies other than the transferer or transferee company. One can have exchangeable debentures which one can exchange into the shares of a subsidiary, and that can be part of the consideration. I believe that this use of the word "shares" in new Section 427A needs a certain amount of clarification.

Turning to the schedule itself, I understand that the draft terms of the merger have to be presented to the court and unless those terms are presented the court cannot sanction the compromise or arrangement. Does that mean that the ratio at which shares are exchanged is frozen until the court decides one way or the other? Let us suppose that I do a deal with the noble Lord, Lord Kissin, and I say to him, "I have a company and you have a company. We are both plcs. We will have a five-for-three exchange". Does that mean that the five-for-three ratio is for ever fixed because we have declared it in our draft terms to the court, or can we go back to the court and say, "In the light of market developments since we undertook this particular transaction, although we should like to continue with it, the ratio should now be four for three"—or five for seven, or whatever it may be? So that is the first point on which I should like clarification.

Secondly, the expert's report to which I referred on the matter of principle raises the question of who can be an expert. I refer to paragraph 5(3) of the draft order. From that, I think it is fairly clear that the expert has to be an accountant; an accountant is the only person who is qualified to be an auditor. In this country we are considering another directive which concerns the regulation of the accounting profession. A number of people will be allowed to act as auditors who are not at present perhaps members of partnerships or of a recognised institute. What happens to the order if the regulations concerning who is allowed to be an auditor change as a result of any government measures?

Another question I should like to put to the noble Lord is: what are the civil liabilities of the expert if he comes to the conclusion that something is reasonable under paragraph 5(7)(d) and it turns out that for one reason or another he is wrong'? What recourse is there for shareholders? Does he have an official status? Does he have a statutory status? I should be most grateful if the noble Lord would offer some comment on that point.

I find it difficult to go through these regulations, which effectively are Bills in short form, during the dinner break when perforce there is only a short period of time available. I hope that the noble Lord will understand that I mean it when I say that this is a very important measure, in my view affecting a number of transactions, schemes or arrangements which have great importance in our commercial life. That is why I believe that these regulations should be taken very seriously and I should be grateful for the noble Lord's comments on my remarks.

My Lords, these directives were made under Article 54(3)(g) of the EC Treaty and as such were subject to the majority voting procedures of that treaty. Since in this country we had had relatively few mergers of the kind covered by these regulations and no divisions involving plcs it was not possible to argue during the negotiations on either directive with any credibility that any vital national interests were at stake in these matters.

We should, moreover, not forget that these directives were seen by a majority of member states as a significant part of the Community's,
"General programme for the Abolition of Restrictions on Freedom of Establishment",
promulgated in 1962 which states that,
"the safeguards required by Member States of companies and firms for the protection of the interests of members and others should, to the extent necessary and with a view to making such safeguards equivalent, be co-ordinated".
Our hope is that the member states and the Commission will in return, in the light of our acceptance of these directives, make progress towards a true common market in the field of services, including insurance and the provision of professional services. I am hopeful that our approach in this matter will assist major advances in the latter fields.

The noble Lord, Lord Williams, asked me a number of questions, and he expressed some surprise that I stated that there had been very few schemes of arrangement that would come under the directives that we are discussing now. We would not suggest that schemes of arrangement are not important, but those covered by the regulations are a very small proportion of such arrangements and this kind of arrangement has occurred relatively infrequently.

On the second point of the noble Lord, Lord Williams, about the vires of the new Companies Bill, it was because the regulations are amending primary legislation that we have adopted the affirmative procedure. The department of course consulted practitioners and took account of their comments on the drafting.

As regards the position of the merchant banks and members of the Issuing Houses Association, which I think is broadly the same thing, I should like to look carefully at what the noble Lord said and reply to him. I have an answer here, but it is rather long and I am not sure whether it covers the exact point that he made. I should like to read what he has said and perhaps he will agree that I may write to him on this subject as soon as possible.

The noble Lord, Lord Williams, also asked how the regulations bite and what kinds of share are involved. We certainly consider that they bite whether or not the shares are preference shares, but not to a formal instrument such as a debenture—

My Lords, on a clarifying point, not to a convertible debenture?

My Lords, again I think that I had better look at that, because I suspect that that form of instrument starts off as one thing and becomes another on conversion. Again, I think I should look at that and come back to the noble Lord in writing.

On the noble Lord's point about whether the ratio of shares is frozen or can be altered subsequent to submission to the court because of market forces changing the relationship between the two share values or for some other reason, the courts will need to work out a procedure to he applied in such cases. I think they would regard that as perhaps being something that is necessary in the light of experience, because no doubt there will be instances when these things happen in real life.

I hope the House will agree that we have achieved a workable result which gives fair weight to the United Kingdom's concerns and experience while not impeding the achievement of wider Community objectives. If there is any other point which the noble Lord made and which I have not fully answered, I shall come back to him in writing after reading what he has said, because I understand that time is rather short.

On Question, Motion agreed to.