UK Listing Rules Reforms: Companies facing financial difficulty

On 29 July 2024 the new UK Listing Rules (UKLR) came into force, representing the most substantial overhaul of the rules in over three decades. For more information about these reforms and their impact on existing and prospective issuers, please see our transactions blog series.

In this blog we highlight the main changes to the UKLR that are relevant to companies experiencing financial difficulty. These include:

• the application of the new significant transaction regime to reconstructions or refinancings, which includes the removal of the requirement for shareholder approval of ‘significant’ or ‘related party’ transactions; 
• updated and simplified requirements for disclosures relating to reconstructions and refinancings, including no longer requiring an FCA vetted circular or the appointment of a sponsor; 
• increased flexibility around dual class share structures (DCSS) which allow for the issue, prior to IPO, of enhanced voting rights shares, which could significantly alter the shareholder dynamics in the context of a restructuring of a listed company with a DCSS; and 
• the removal of the 1% market cap on break fees, impacting what could be negotiated in the context of distressed M&A.

The changes made to the UKLR will mean that, going forward, some procedural hurdles that used to be required to restructure listed companies in financial distress are removed. Despite this, the increased flexibility around DCSS, and the de facto removal of the 1% cap on break fees for M&A (including distressed M&A), may have the unintended consequence of resulting in more expensive and more complex restructuring transactions.

Removal of requirement for a shareholder vote on ‘Significant’ or ‘Related Party’ transactions 

Where a transaction is undertaken by a company facing financial difficulty, the new significant transaction regime will apply. ‘Financial difficulty’ is not defined in the UKLR, and there is no FCA guidance elaborating on the concept. As such, it could potentially cover both moderate cases requiring standard refinancings, or severe financial distress where a company is insolvent and liquidation or administration is likely. Under this updated significant transaction regime, no prior shareholder vote or shareholder circular will be required for a ‘significant transaction’ (i.e. a transaction where any one class test ratio is 25% or more (what used to be known as a ‘Class 1’ transaction) – such as a large disposal to raise finance) or a ‘related party transaction’. Shareholder approval will still be required for reverse takeovers and delistings. However, the removal of such requirements does not exclude UK MAR obligations, so listed companies will still need to be conscious of their disclosure obligations. Updates to guidance on selective disclosures in DTR 2.5.7G make it clear that shareholders can still be consulted about proposed transactions, even where a shareholder vote is not required.

The removal of the ability of shareholders to veto significant transactions aims to increase deal certainty for companies carrying out significant transactions and remove a perceived disadvantage for companies whose shares were admitted to the premium listing segment of the FCA’s Official List as compared to companies listed elsewhere. The FCA in its responses to stakeholder feedback does acknowledge that shareholders perceived this ability to veto the board as an important safety net and attractive stewardship mechanism for investors. Nevertheless, this change “places more emphasis on boards to make decisions that preserve or increase (rather than erode) shareholder value” – something they are required to do by law, and in line with their fiduciary duties as directors. 

When a company is facing financial difficulty, e.g. where it is insolvent or bordering on insolvency, or an insolvent liquidation or administration is probable, directors are obliged to take into account the interests of creditors, and balance these against the interests of shareholders where they conflict. Often in these scenarios, where insolvency is imminent, immediate and swift action is required, and removing the requirement to convene a general meeting and obtain shareholder approval will likely enable companies to act more quickly, and more effectively in the interests of all stakeholders to whom they owe a duty.

Enhanced notification requirements but no concept of “severe financial difficulty”

As a trade-off for the removal of a compulsory shareholder vote, under the new regime, significant transactions will require enhanced market notifications. Announcements to the market will be required at three points during the transaction: first, at an early stage, when the terms of the proposed significant transaction are agreed; second, a more detailed follow-up announcement as soon as possible after the terms are agreed and relevant information has been prepared or the listed company becomes (or ought reasonably to have become) aware of the information; and third, a final notification as soon as possible after completion confirming that the transaction has closed and there has been no material change affecting any matter previously disclosed in relation to the transaction. The UKLR contains guidance on disclosure for companies entering into a transaction to alleviate actual or anticipated financial difficulty. The notification required should set out the nature, urgency and severity of the financial difficulty, and may also contain information about financing arrangements connected to the transaction, and the consequences of the proposed transaction not completing.  The initial announcement is also subject to a ‘sweeper’ provision that requires disclosure of any further information the company considers relevant, having regard to the purpose of the significant transaction rules.

There is however no requirement for a working capital statement in such scenarios (as was previously the case for the old Class 1 transaction). In place of the working capital statement, protections are in the form of increased reliance on broader obligations not to publish misleading statements, UK MAR requirements, and existing statutory and fiduciary duties of directors, who now have discretion as to how those duties are appropriately discharged. As with other significant transactions under the new regime, the FCA will not require issuers to appoint a sponsor where they are undertaking a transaction due to financial difficulty, although a sponsor will be required if the issuer proposes to request the FCA to waive, modify or substitute the operation of the UKLR or is seeking guidance from the FCA. 

Under the new significant transaction regime, which applies to reconstructions and refinancings, announcements are abolished for what were previously termed ‘Class 2’ transactions (i.e. a transaction where any of the class tests is ≥5%, but each is less than 25%). The issuer’s disclosure obligations under UK MAR will, however, need to be complied with. 

Where transactions are entered into in the ‘ordinary course of business’ they are exempt from the ‘significant’ or ‘related party’ transactions regimes. New guidance from the FCA however, clarifies that transactions which are entered into to alleviate financial difficulty are unlikely to be in the ‘ordinary course of business’, and therefore are unlikely to qualify for this exemption.

In its original proposal the FCA introduced the concept of ‘severe financial difficulty’ and proposed enhanced disclosure obligations for transactions intended to alleviate such ‘severe financial difficulty’. However, this proposal was dropped due to concerns by stakeholders that, amongst other things, the concept was complex and undefined, guidance of a sponsor would likely be required, requiring additional and substantial due diligence beyond the transaction due diligence itself, and this approach would impose friction on often time-sensitive transactions. Instead, the FCA have introduced guidance outlining their expectations on this point and the types of information issuers should consider disclosing.

Updated and simplified requirements for circulars relating to reconstructions and refinancings 

Under the new significant transaction regime, the requirement for an FCA-approved shareholder circular in relation to a reconstruction or refinancing is removed. However, where a listed company does produce a circular (where it is, for example, required under the UK Companies Act or other legislation), which includes proposals to be put to shareholders in a shareholder meeting in respect of a reconstruction or refinancing, under the new rules: the appointment of a sponsor will no longer be mandated; the circular no longer needs to contain a working capital statement; and the draft circular will no longer require FCA approval. 

In their policy statement, the FCA noted concerns that these previous requirements added friction during an often acute and critical point in a company’s life. The FCA is however clear that shareholder protections will be upheld despite the relaxation of the requirements, and circulars will still have to comply with the FCA’s general requirements for circulars in the UKLR – including, where a vote is required, the requirement to contain all information necessary to allow the security holders to make a properly informed voting decision – and at common law, restructurings and refinancings remain subject to directors’ duties and applicable law.

Reforms in relation to enhanced voting rights / dual class share structures (DCSS)

The new UKLR permit pre-IPO institutional investors that are legal persons to hold enhanced voting rights shares. These enhanced voting rights are time limited and must expire after a maximum of 10 years. There will be no limit on the voting ratio, however, enhanced voting right shares will not be able to be issued following listing. Companies that have an existing DCSS will be capable of admission to listing, on the basis that there is sufficient disclosure of the relevant rights in the prospectus. This reform is based on the FCA’s view that investors should be able to price in the risks themselves, and that regulation of DCSS should as a general rule be minimised – bringing the UK in line with other major listing regimes, such as the US.

Holders of such ‘specified weighted voting rights shares’ will be able to cast multiple votes on most resolutions, subject to some exclusions. Holders of high vote shares will be able to vote to elect and re-elect independent directors, vote on reverse takeovers, and they may also be able to hold different rights as to entitlement to any surplus capital on a winding-up. 

The existence of a DCSS in a distressed listed company could significantly change the shareholder dynamic in the context of a restructuring. If, for example, a founder retains enhanced voting rights shares in a post-IPO scenario, it may mean that instead of having to interact with a broad and disparate shareholder base during a restructuring, there may be a more consolidated centre of power (i.e. the founder with weighted voting rights shares), meaning the dynamic is slightly more similar to a restructuring of a private company with a controlling sponsor, than would otherwise be the case.

 Removal of the 1% market cap on break fees

Under the new UKLR, break fees (of any size) will not constitute significant transactions. Under the previous regime, a break fee of over 1% of the market capitalisation of the company in question was to be treated as a Class 1 transaction. This effectively put an upper limit on break fees for UK listed companies. It may be the case that, by removing the classification as a significant transaction and thereby the requirement for shareholder approval, UK companies will see an inflation in the break fees demanded by counterparties in global and domestic M&A processes (e.g. market practice in the UK may begin to be influenced by, for example, the US market practice, where the break fees are significantly higher – often between 4-6%) - although in agreeing to a break fee the directors of the company giving the break fee will need to be comfortable that they are discharging their directors’ duties. This could have an impact on what could be negotiated in the context of distressed M&A, where often the stakes are high for the parties involved, and substantial break fees could be demanded by prospective buyers, exploiting the distressed nature of the seller’s position.