Magic circle corners market as businesses turn to rights issues
23 February 2009
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As the economy worsens, companies are looking to squeeze shareholders for extra capital.
A glut of rights issues are anticipated over the coming months, as cash-strapped companies turn to their shareholders to raise extra capital.
Relatively rare during a boom period, share issues are a vital source of money when the credit markets dry up.
There should also be a welcome revenue boost for IPO lawyers, who have seen flotations virtually disappear in recent months.
But the market is dominated by a small group of elite firms, making it hard for anyone outside the magic circle to get a look in.
The two biggest rights issues to take place so far in 2009 – from British Land and mining group Xstrata – involved old adversaries Freshfields Bruckhaus Deringer and Linklaters, with the former acting for the companies while the latter advised the underwriting banks.
Going back to 2008, those two, plus Allen & Overy (A&O) and Slaughter and May, have snared virtually all the significant instructions.
The most lawyer-heavy and sought-after role is the one acting for the listed company offering shares. Here the mandate tends to fall on the company’s regular adviser – hence the presence of Slaughter and May on so many issues in the past six months.
“The company’s role is usually bigger and you’d expect the company lawyers to do most of the heavy lifting on the prospectus – although acting for the banks is more of a role than it used to be,” reveals Freshfields head of corporate finance Barry O’Brien.
The underwriters’ role has taken on a new significance following the high-profile failure of several rights issues last year.
Capital raisings by Bradford & Bingley, HBOS and Royal Bank of Scotland (RBS) were snubbed by investors, leaving the underwriters having to make up the shortfall. Banks are now fighting hard to ensure they have a get-out clause in case the issue gets into trouble.
“Underwriting agreements have traditionally been fairly standard. Now there are some good old-fashioned negotiations about what the right thing to do is,” says O’Brien.
When it comes to acting for the underwriters it appears to be a straight two-firm fight between Linklaters ;and ;Freshfields (although Ashurst and A&O won places last year acting on offerings by Imperial Tobacco and Carlsberg respectively). Linklaters has stolen a march on its rival, advising the underwriters on the last five rights issues as reported by The Lawyer.
But why are these two proving so hard to shift from the underwriting role?
“It’s a question of going to the people who did the last one,” says Slaughters corporate partner Nilufer von Bismarck. “It just makes life easier. You end up with a self-perpetuating cycle that’s difficult to break. We like to
think we’re on top of the issues. Freshfields and Linklaters would probably say the same.”
Slaughters is notable by its absence from the list of firms advising banks on rights issues, even considering its smaller banking practice. O’Brien’s explanation is that banks prefer a firm with a US practice because institutional shareholders are often based in the country.
“The key differential is whether or not you have US capability,” he says. “If not, you’re at a disadvantage if you’re going to include the US shareholders. Slaughters, for example, is at a disadvantage because it doesn’t have US capability.”
But von Bismarck argues that Slaughters has won the biggest underwriting ;deal ;of ;them all, helping the Government recapitalise the banks.
She points out that the recapitalisation had many characteristics of a conventional rights issue: new shares were created and offered to shareholders, a process underwritten by the Government, which took up the vast majority of the issue.
The current fashion for capital raisings looks set to accelerate in the coming months.
New rules from the Financial Services Authority came into force this month allowing companies to carry out a rights issue in as little as 10 days. The move is intended to allow companies to raise capital more quickly and prevent some of the high-profile failures of last year, which saw shares in RBS, Bradford & Bingley and HBOS plunge amid a flurry of short-selling.
New guidelines released by the Association of British Insurers also make it easier for executives to make a cash call. A shareholder vote is now only required if share capital is being increased by more than two-thirds, compared with the previous threshold of one third.
However, carrying out a rights issue is not without its problems and the legal pitfalls are myriad.
The Bradford & Bingley cash call, a Herbert Smith mandate, is now the subject of court action from a group of the bank’s small shareholders, who claim they were deceived by the prospectus.
Only half of the new shares were taken up, with the rest picked up by underwriters, but all lost their money when the bank was nationalised shortly afterwards.
Leon Kaye, of Leon Kaye Solicitors, is leading the case. “The essence of our claim is that the prospectus was misleading and omitted crucial information which, if it had been known, the investors would have been unlikely to have put the money up,” he explains.
The action is against Bradford & Bingley’s management and at this stage says that the lawyers involved are not in the firing line, but the dangers of getting a prospectus wrong are clear. If more banks are forced into national ownership, the legal experts who worked on their rights issues will be thrust into the spotlight.