Restrictions apply to US shareholders wanting to participate in unlisted UK companies' rights offerings, but there are exemptions available

With banks unwilling to lend and public markets all but closed, UK companies have been tapping their existing shareholders for cash by means of rights offerings. According to Trowers & Hamlins partner Richard Hilderbrand, who has been involved in several UK rights offerings, such rights offerings by UK companies that are not listed on US exchanges, typically contain language excluding US shareholders from participating in the offer and prohibit sending the UK prospectus into the US. US shareholders may, however, participate in a rights offering, and the company may send the prospectus into the US, if an exemption from the registration requirements of the US Securities Act of 1933 is available.

So what exemptions are available to enable US holders to take up their rights?

There are two types of exemptions: a public offering exemption and a private placement exemption. The public offering exemption, afforded by Rule 801 of the US Securities Act, applies if: (i) the company is a foreign private issuer, which generally means that it is a non-US company and that no more than 50% of its outstanding securities are owned, of record, by US residents and (ii) at any time commencing 60 days before or 30 days after the record date of the rights offering, US residents beneficially hold no more than 10% of the company's outstanding class of securities that is the subject of the rights offering, and certain other conditions apply.

In determining this threshold amount of US resident shareholders, one must include all US holders whose shares are held in the names of brokers and other nominees located in the US, the company's country of incorporation and the company's primary trading market.

The Rule 801 exemption is only available for the sale of the rights shares by the company, not for the resale of the rights shares by purchasers from the company. Accordingly, the rights shares issued to US holders pursuant to Rule 801 are restricted securities that cannot be sold in the US absent an exemption from registration. They can, however, be freely sold on the London Stock Exchange in accordance with the requirements of the exemption afforded by Rule 904 of RegulationS.

The private offering exemption, afforded by Section 4(2) of the US Securities Act, permits the sale of the rights shares to US high-net-worth individuals and institutions that have not been reached by any form of general solicitation or advertising, who qualify, at a minimum, as accredited investors and who purchase the rights shares in a private placement for investment purposes and not with a view to distribution. Before the UK prospectus is distributed to such US holders, they should be required to sign a letter in which they represent that the foregoing is true and in which they acknowledge that the rights shares are restricted securities that can only be sold pursuant to an appropriate exemption from registration.

In selling the rights shares outside the US, the company will rely on Regulation S of the US Securities Act, provided that, among other conditions, the company does not engage in so-called directed selling efforts, which means activities that are targeted at US holders to encourage them to purchase the securities and, provided further, that the prospectus states that the nil paid rights, the fully paid rights and the rights shares have not been registered under the US Securities Act and are not being offered or sold in the US unless an exemption is available.

In conducting the US private placement alongside the UK rights offering, particular care must be taken to separate the two activities from each other so that the UK public offering does not involve the US private placement in a general solicitation and the US private placement does not involve the UK public offering in prohibited directed selling efforts. Accordingly, in addition to keeping publicity about the US private placement to a minimum, the company should preclude shareholders who responded to the UK public offering from participating in the US private placement, limit access to the prospectus posted on the company's website to persons who demonstrate that they are not US persons and refrain from any mention of the US private placement in the UK prospectus.

Ineligible US holders, for whom no registration exemption is available, will not be able to take up their rights. It is customary in UK rights offerings for the company, or the subscription agent on its behalf, to place such rights shares outside the US in accordance with Rule 903 of Regulation S and credit the ineligible US holders with any net sales proceeds. Whether such an activity would be permitted without registration under the US Securities Act may depend on whether it can be viewed as a permissible vendor placement.

In the context of tender offers and exchange offers, the Securities and Exchange Commission permits such vendor placements without registration on condition that the market for the bidder securities issued to the US shareholders is highly liquid and the number of bidder securities to be issued to US holders is relatively small compared to the total number of bidder securities outstanding. It is arguable however, that such conditions do not apply to a vendor placement in the context of a rights offering because the US shareholder is not giving any consideration for the rights.

In the case of an underwritten rights offering, the rights shares not taken up by ineligible US shareholders can be resold by the underwriter in the US to certain institutions. Such resales may, however, increase the cost of the rights offering since it is likely that the underwriter will seek negative assurance letters from the US lawyers, and this would require a heightened level of due diligence and disclosure similar to that which would be required if the rights shares were to be registered in the US.

Raphael Grunfeld is a partner at Carter Ledyard & Milburn.