Schemes of Arrangement and the Headcount Test

Schemes of arrangement are a popular way to privatise or restructure companies but the threshold for approval of a scheme of arrangement carries an olde sting in the application of the headcount test. 
 
Schemes require approval by a majority in number (headcount test) of members holding 75% in nominal value of the relevant shares.
 
The headcount test, originally enacted by the Companies Act 1862, wasdevised for creditor’s schemes of arrangement to avoid creditors with large claims having the ability to “carry the day”.  When schemes were extended to members by the Companies (Consolidation) Act 1908, the headcount test was retained. 
 
The headcount test is simple statutory test.  It is a majority (50% plus one) of the registered members (or each class of registered members) who vote on the scheme, either in person or by proxy, irrespective of the number of shares held by each member. 
 
"Member" is usually defined in the applicable company’s legislation.  In Bermuda, for example, section 19(2) of the Companies Act 1981 provides that every person who agrees to become a member of a company, and whose name is entered in its register of members, shall be a member of the company.  There is a similar provision in the Cayman Islands in section 38 of the Companies Law (2013 Revision) and in the BVI, although section 78 of the BVI Business Companies Act, 2004 applies the same meaning of "member" to the term "shareholder".
 
This test causes difficulties in today’s equity markets where shares are registered in the name of a central depositary and not in the names of the beneficial owners of the shares.  In such a case the headcount test can only apply to the central depositary and not to the underlying participants in the depositary system or to the beneficial owners of the shares who therefore do not have the right to be counted in the calculation of the requisite majority in number of members. 
 
The principles applied in the case of Eckerle and others v Wickeder Westfalenstahl GmbH and another[2013] EWHC 68 (Ch); [2013] WLR (D) 24 are a welcome confirmation of the correct principles which apply in ascertaining the voting rights of "members" as opposed to beneficial owners of shares.  These principles can be used in the calculation of the headcount test required to approve schemes of arrangement involving companies incorporated in Bermuda, BVI and the Cayman Islands.
 
The case concerned DNick Holding plc, a public limited company incorporated in England and listed on the Deutsche Borse.  The shares of DNick were mainly held by Bank of New York Depositary (Nominees) Limited (BoNY) as the central depositary in Clearstream, the clearing and settlement system of Deutsche Borse.  BoNY held the DNick shares on trust for the account holders in Clearstream.
 
A special resolution was passed to de-list DNick's shares from the Deutsche Borse and DNick was re-registered as a private limited company.
 
The claimants, who were account holders in Clearstream, alleged that their beneficial interest in DNick's shares gave them standing to apply to the court for the cancellation of the special resolution under section 98 of the Companies Act 2006.  Section 98(1)(a) provides that such an application may be made "by the holders of not less in the aggregate than 5% in nominal value of the company's issued share capital".

The High Court summarily dismissed the claim and held that the claimants were not "holders of shares" as their names were not entered in the register of members of DNick.  The term “holders of shares” did not extend to persons holding a beneficial interest in the shares, for example by being account holders in a central depositary system such as Clearstream.
 
Norse J stated that a ‘shareholder’ or ‘the holder of a share’, which were indistinguishable terms, was one (and only one) whose name was registered in the register of members.  "There would in my view have to be an extremely strong reason to read the expression ‘the holders of not less in the aggregate than 5% in nominal value of the company’s issued share capital’ in a sense different from that indicated by the orthodox understanding of company law”. 

The judge acknowledged this was not a particularly comfortable conclusion for persons who held their shares indirectly in depositary systems.  However, to reach any other conclusion would be "an impermissible form of judicial legislation".
 
BoNY, holding shares in Clearstream or HKSCC Nominees Limited holding shares in CCASS, the central clearing system of the HKEx, for example, would therefore only count as one member for the purposes of calculating the statutory majority in number of members required to approve a scheme of arrangement. 
 
There is another test which may be judicially applied to schemes of arrangement to safeguard the interests of shareholders or beneficial owners and which is discretionary.  It is whether or not a fair cross section of shareholders have approved the scheme.  For this purpose it may be appropriate to 'look through the register' and beyond the registered member to determine the vote of the underlying beneficial owners, to the extent practicable, and a directions order that this be done can usually be obtained at the directions hearing.  
 
David Lamb is a partner and co-chairman of Conyers Dill & Pearman based in the Hong Kong office.  His practice includes all aspects of corporate law with particular experience in corporate finance, capital markets M&A, schemes of arrangement, mergers, tender offers, squeeze-outs, proxy fights and battles for board control.  He has been involved in a number of significant M&A transactions involving Bermuda, BVI and Cayman Islands companies listed on many of the world's major stock exchanges.   David has been recognised in Chambers Asia 2012, 2013 and 2014 and is “rated for his pre-eminent expertise in M&A.”