City law in practice - Case Study 6: Legal & General rights issue
1 December 2002
1 December 2002
1 May 2003
2 July 2008
26 October 2007
1 February 2006
Companies can use a number of methods to raise money. They can simply borrow from banks or seek new investors. Alternatively, they may raise funds by use of a rights issue, where they ask their shareholders for money in exchange for more shares. BT's £5.9bn rights issue last May triggered a wave of similar deals by companies that included KPN, ICI, Kingfisher and Ericsson.
Business analysts predict that the trend will continue, especially in the insurance sector, where companies are feeling the strain caused by the continued decline in share prices and an increase in insurance claims following 11 September and last summer's flooding across Central and Eastern Europe. Recently completing rights issues were Legal & General Group (L&G), Hiscox and Zurich Financial Services (Zurich), and there are strong rumours that Swiss Life is next.
What is a rights issue?
A typical UK rights issue is an offer of new shares or other securities made by a listed company to its shareholders. They are offered the 'right' to take up new shares and, should they decide not to, they can sell their right to a third party.
Unless the company's shareholders consent, the new shares must be offered by the company in proportion to their existing holdings (see Section 89 of the Companies Act 1985).
Any shares taken up are paid for in cash. In order to persuade shareholders to accept the offer, new shares are generally offered at around 15 per cent below the market price.
Occasionally, companies offer shares at a substantial discount, known as a 'deep' discount. This usually happens when a company is forced into a rights issue because it desperately needs cash, or because of adverse market conditions. The rights issues by BT, Zurich and L&G were deeply discounted.
A company can use the proceeds of a rights issue to do any of the following: to reduce its debts (eg by repaying loans); to boost its cash reserves; to fund capital expenditure (eg the purchase of equipment etc); or to finance a takeover, merger or acquisition.
Additionally, companies in the insurance or financial sectors that are experiencing a significant fall in the value of their assets (eg shareholdings in other companies) can use the proceeds of a rights issue to bolster their balance sheet. The $2.5bn (£1.6bn) raised by Zurich was used for this purpose.
Insurance companies invest their policyholders' money into the stock markets; so if share prices drop, the level of their assets risk falling below the thresholds set by the Bank of England. If this occurs, insurance companies must rectify the problem swiftly.
The main advantage of a rights issue is that it enables a company to reduce debt on its balance sheet without paying back borrowings. But for shareholders it often leads to a dilution of their stake in the company.
The Legal & General rights issue
L&G completed a £785.9m deep discount rights issue on 22 October this year. The rights issue was the first in the UK insurance sector for almost 20 years. Unlike Zurich, the proceeds of L&G's rights issue will be used to fund capital expenditure.
L&G, which was advised by Slaughter and May, issued up to 1.34 billion new shares at 60p each, almost a 50 per cent discount on the market price. Shareholders were offered 13 shares for every 50 that they already owned.
The L&G rights issue was conditional upon the occurrence of the following events:
the shareholders passing resolutions at an extraordinary general meeting (EGM) to increase L&G's share capital (ie to create the new shares) and to authorise the directors to allot (ie offer the shares) pursuant to Sections 123 and 80 of the Companies Act 1985.
the admission of the new shares to the UK Listing Authority (UKLA) Official List by 27 September 2002.
all the conditions in the underwriting agreement being satisfied.
Enter the underwriters
L&G's rights issue was fully underwritten by two investment banks - UBS Warburg and Dresdner Kleinwort Wasserstein. The banks, which also coordinated the deal, were advised by magic circle firm Linklaters.
The banks entered into an underwriting agreement with L&G, in which they agreed to take up any leftover shares after the rights issue was completed. In return UBS and Dresdner (the underwriters) were paid a commission of up to 1.625 per cent of the total value of the shares issued.
A typical underwriting agreement also contains a number of conditions, including the passing of relevant shareholder resolutions and the admission of the new shares to the UKLA Official List. The second condition is very important to the underwriters and sub-underwriters, because they would not want to take up unlisted shares that cannot be traded on the London Stock Exchange (LSE).
It also contains various representations and undertakings from the company to the underwriters. For example, the company usually represents that information in the prospectus is true and accurate. If any representations or undertakings are breached, the underwriters can terminate the agreement.
L&G's principal steps
Build-up to impact day
Legal & General Group (L&G) and its professional advisers structure deal and work on issue documents
Impact day -1
L&G directors' meeting is held to approve the deal, to set the issue price and sign the underwriting agreement
Impact day (10 September)
Rights issue is announced (deal becomes public), prospectus posted to L&G shareholders, UBS Warburg and Dresdner Kleinwort Wasserstein arrange sub-underwriting
Impact day +17
Extraordinary general meeting is held, where L&G shareholders pass ordinary resolutions and the Provisional Allotment Letters (PALs) are posted
Impact day +18
Dealings in PALs start
Impact day +39
Last day for L&G shareholders to take up shares and submit payment
Impact day +40
UBS and Dresdner attempt to sell 'rump' (if any)
Impact day +41
Sub-underwriters informed of 'stick' (if any)
Impact day +42 (22 October)
L&G rights issue closes
Impact day +80
Shares issued to people who chose to take up offer
The countdown to impact day
Due to the complexity of a number of the issues in the L&G rights issue, only the principal steps are referred to. Issues such as the treatment of overseas shareholders, CREST mechanics, fractional entitlements and tax structuring have been omitted.
Once the impact date had been agreed (ie the day the rights issue becomes public), L&G and its advisers began work in earnest on the following issue documents: the press announcement; the prospectus incorporating the circular; and provisional allotment letters (PALs).
The prospectus, which needs to be approved and stamped by the UKLA, is a lengthy document setting out the purpose of the rights issue and details of the terms of the offer. It also contains detailed financial and non-financial information relating to the company's business, disclosed in accordance with the Listing Rules of the UKLA (commonly known as the Purple Book). The disclosures are necessary to enable investors to determine the health of the company and its future prospects.
The UKLA will impose severe penalties on the company's directors if the information in the prospectus is misleading or inaccurate. Therefore, the lawyers check thoroughly the contents of the prospectus with the company's assistance. This exercise is called verification and is typically the responsibility of a trainee or junior assistant solicitor.
Because one of the conditions to L&G's rights issue was the passing of relevant shareholder resolutions, the front end of the prospectus also contained a circular. The circular, which always starts with a letter from the company's chairman, is essentially the notice inviting shareholders to attend the EGM.
Just before impact day, UBS and Dresdner, which also acted as joint brokers, made a confidential application for the listing of L&G's new shares to the UKLA; and the night before, L&G's directors set the share price and approved the underwriting agreement and issue documents.
On impact day (10 September), the press announcement was released and copies of the prospectus were sent to all UK shareholders, so the rights issue became public.
Also, UBS and Dresdner in their capacity as joint brokers arranged sub-underwriters to which their risk was passed. The sub-underwriters, which are normally professional investors such as pension funds, are appointed on the same terms as the underwriters and receive the same commission.
On 27 September, 17 days after impact day, L&G held an EGM where its shareholders passed two 'ordinary' resolutions, which require a 50 per cent majority, the first being the creation of the new shares and the second authorising the directors to allot. The gap between the two dates would have been longer (24 days) if L&G required its shareholders to pass a 'special' resolution, requiring a 75 per cent majority, disapplying pre-emption rights.
Where an EGM is unnecessary, the PALs and prospectus are posted together. But in L&G's case the PALs were posted immediately after the EGM.
A PAL is a temporary document of title by which L&G's new shares were provisionally allotted to shareholders. The PALs showed the shareholders' entitlement to the new shares, which they were required to accept by 22 October. Section 90(6) of the Companies Act 1985 obliged L&G to give its shareholders 21 days to accept the offer.
A shareholder who chooses to accept the offer and pays the relevant amount is eventually sent a share certificate. In the meantime, the PAL will be their temporary document of title, which they can trade on the stock market.
A shareholder who does not wish to take up the shares has the choice to do nothing, in which case the PAL will lapse, or to sell the PAL on to an interested third party.
The rump and the stick
Once the offer period closes, the brokers attempt to sell the lapsed PALs (known collectively as the 'rump') on the LSE to other investors. If the broker is unsuccessful then the sub-underwriters must honour their commitment and take up any leftover PALs (known collectively as the 'stick').
L&G's shareholders took up approximately 95 per cent of the new shares. The rump was then sold to other investors at 105p each. The net proceeds of the sale were paid to L&G's shareholders whose PALs had lapsed. Consequently, neither the underwriters nor the sub-underwriters needed to take up any leftover shares.
UK Listing Authority (UKLA)
Responsible for regulating the activities of companies on the London Stock Exchange.
Official List of the UKLA
A list of companies maintained by the UKLA whose shares can be traded on the LSE.
A company with shares listed on the UKLA Official List.
An offer of shares at a 50-75 per cent discount to the market price.
The investment banks that agree to take up any leftover shares from a rights issue.
A lengthy document setting out certain information relating to the health and future prospects of the company.
Sets out the rules regulating the behaviour of public limited companies.
Provisional allotment letter (PAL)
A temporary document of title evidencing a shareholder's right to take up shares in the company, which may be traded on the London Stock Exchange.