Scheme of Arrangement

Last updated June 2009

M&A, MBO and privatisation

A scheme of arrangement is a court approved process used by companies in e.g. Hong Kong under the Hong Kong Companies Ordinance to re-organise their affairs or corporate structure. The scheme of arrangement is often use in relation to M&A (merger and acquisition), MBO (management buy-put) or privatisation.

Dual Requirements under a Scheme of Arrangement

Section 166 of the Hong Kong Companies Ordinance sets out the "dual requirements" of a scheme of arrangement:

"166. Power to compromise with creditors and members
(1) Where a compromise or arrangement is proposed between a company and its creditors or any class of them, or between the company and its members or any class of them, the court may, on the application in a summary way of the company or of any creditor or member of the company, or, in the case of a company being wound up, of the liquidator, order a meeting of the creditors or class of creditors, or of the members of the company or class of members, as the case may be, to be summoned in such manner as the court directs.
(2) If a majority in number representing three-fourths in value of the creditors or class of creditors, or members or class of members, as the case may be, present and voting either in person or by proxy at the meeting, agree to any compromise or arrangement, the compromise or arrangement shall, if sanctioned by the court, be binding on all the creditors or the class of creditors, or on the members or class of members, as the case may be, and also on the company or, in the case of a company in the course of being wound up, on the liquidator and contributories of the company."

Similar legislation exists in England, Australia, New Zealand and South Africa and some Commonwealth countries, per Lord Millet NPJ in UDL Argos Engineering & Heavy Industries Co. Ltd. [2001] HKCFA 19.

The reason of the dual requirements was explained by Barma J in In the matter of PCCW Limited （電訊盈科有限公司） [2009] HKCA 178:

"The requirement of a 75% majority by value is designed to ensure that only proposals that have the support of a substantial majority in value terms of the class in question will become binding on all members of the class. It has the effect that a large number of small shareholders, amounting to a numerical majority in terms of headcount, cannot cause a proposal to become binding on a minority with a substantial shareholding. But the majority by number criterion also serves a purpose, that being to provide a degree of protection for the interests of the smaller shareholders, by ensuring that a proposal which does not enjoy broad based support among shareholders individually cannot be forced through by a small minority of individual shareholders who between them control a large stake in the company. In an extreme case, absent the headcount requirement, a single shareholder holding 75% of the shares in the class voting on the proposal would be in a position to ride roughshod over the objections of all other shareholders in that class."

Nature of Scheme of Arrangement Proceedings

Lam J in PCCW explained the nature of a scheme of arrangement:

"Proceedings to seek the court'ss sanction for a scheme of arrangement are summary in nature. It has to be made by petition (Order 102 Rule 5(1)(h) Rules of the High Court). Evidence is usually adduced by affidavits or affirmations and there is no discovery. Cross-examination is rare, if not unheard of. The application is usually heard within a tight timeframe to fit the time-table of the scheme mandated by financing conditions and other regulatory regimes."

"[The proceedings] are not ordinary adversarial civil litigation. The onus falls squarely upon the petitioner to satisfy the court that the scheme should be approved. On many instances, section 166 applications are disposed of on an ex parte basis. Even so, in the exercise of its Section 166 jurisdiction, the court would have to examine the application and satisfy itself that the scheme is one which, as an intelligent and honest man, a member of the class concerned in acting in respect of his interest might reasonably approve of."

"the jurisdiction of the court is quasi-inquisitorial. If the court has relevant queries pertinent to the approval of the scheme which the documents and the meetings do not appear to address, the court is entitled to raise the same and in the absence of satisfactory answer from the petitioner it can withhold its sanction. Thus Buckley acknowledged that whilst the court will be slow to differ from the meeting it may do so when some blot is found in the scheme. At footnote 2 of para.425.54 of the current edition of Buckley, it is said that a blot on a scheme means a defect in the scheme which escaped notice and only came to light after the meeting (see also Re Equitable Life Assurance [2002] 2 BCLC 510 at p.539). The court is not a mere rubber stamp."

3 Stages of Creditors Scheme of Arrangement

Chadwick LJ in Re Hawk Insurance Company Ltd [2001] EWCA Civ 241 observed that they may be three stages in a Scheme of Arrangement between a company and its creditors or a class of its creditors:

• (a) an ex parte application to the court for an order that one or more creditors meetings be convened
• (b) the scheme proposals are put to the meeting and approved by a majority in number representing 75% in value of the claims of those present and voting in person or by proxy
• (c) if the scheme of arrangement is approved at the meeting, the court may but not bound to sanction the scheme.

Scheme of Arrangement Practice in England

The practice in England was established by a Practice Note issued by Eve J in [1934] WN 142 which laid down inter alia that it was the responsibility of the company to decide how the meetings should be constituted. If meetings were incorrectly constituted or objection was taken the company must take the risk of the application being dismissed cf. Lord Millet in UDL Argos Engineering.

Scheme of Arrangement Meetings

The following principles are relevant in relation to scheme of arrangement meetings (per Lord Millet in UDL Argos Engineering):

• (1) It is the responsibility of the company putting forward the Scheme to decide whether to summon a single meeting or more than one meeting. If the meeting or meetings are improperly constituted, objection should be taken on the application for sanction and the company bears the risk that the application will be dismissed.
• (2) Persons whose rights are so dissimilar that they cannot sensibly consult together with a view to their common interest must be given separate meetings. Persons whose rights are sufficiently similar that they can consult together with a view to their common interest should be summoned to a single meeting.
• (3) The test is based on similarity or dissimilarity of legal rights against the company, not on similarity or dissimilarity of interests not derived from such legal rights. The fact that individuals may hold divergent views based on their private interests not derived from their legal rights against the company is not a ground for calling separate meetings.
• (4) The question is whether the rights which are to be released or varied under the Scheme or the new rights which the Scheme gives in their place are so different that the Scheme must be treated as a compromise or arrangement with more than one class.
• (5) The Court has no jurisdiction to sanction a Scheme which does not have the approval of the requisite majority of creditors voting at meetings properly constituted in accordance with these principles. Even if it has jurisdiction to sanction a Scheme, however, the Court is not bound to do so.
• (6) The Court will decline to sanction a Scheme unless it is satisfied, not only that the meetings were properly constituted and that the proposals were approved by the requisite majorities, but that the result of each meeting fairly reflected the views of the creditors concerned. To this end it may discount or disregard altogether the votes of those who, though entitled to vote at a meeting as a member of the class concerned, have such personal or special interests in supporting the proposals that their views cannot be regarded as fairly representative of the class in question.

Scheme of Compulsory Acquisition under S. 168 of the Companies Ordinance

The scheme of arrangement can be contrasted with a scheme of acquisition under s. 168 of the Companies Ordinance. An offeror can choose to proceed under Section 166 instead of Section 168 cf. Re National Bank Ltd [1966] 1 WLR 819, In re Savoy Hotel Ltd [1981] 1 Ch 351 and In the matter of TDG plc [2008] EWHC 2334 (Ch) but the "mechanics and onus" of the two routes are different. Lam J in PCCW explained:

"Under that statutory route, an offeror put forward a scheme of acquisition and obtained the acceptance of 90 per cent of shareholders, he could compulsorily acquire the remaining 10 per cent. Instead of the court giving sanction, the section provided for application to be made by the dissenting shareholder seeking an "otherwise order" from the court. In such application, the onus was on the dissenting shareholder to show that the scheme was unfair."

However, as Lord Evershed MR made clear In re Bugle Press Ltd [1961] Ch 270, in the case of section 168, the onus would be reversed once the minority shareholder shows that the 90 per cent shareholders are not independent.

^