The 48 hours nobody talks about: settling employee share awards on a scheme of arrangement

Much of the discussion around employee share plans on a public takeover understandably focuses on outcomes.

Will awards vest? Will performance conditions be tested? Will awards be time pro-rated? What will participants receive?

But once those questions have been answered, there is another problem to solve. The resulting share entitlements need to be created or sourced, placed into the right hands, registered in the right place by the relevant Scheme Record Time and converted into takeover consideration. That consideration may then need to be routed back through the target's payroll so that tax can be withheld before the net proceeds reach participants.

On a scheme of arrangement, those steps can converge within a very short window.

The difficult part is therefore not always deciding what participants should receive. It can be making sure that the shares, cash, documents and instructions all arrive in the right place, in the right order, at the right time.

Start at the end

The most useful starting point is often the Scheme Record Time.

Ask a simple question: what shares need to be sitting where at that moment?

Consider an LTIP under which participants become entitled to shares when the Court sanctions the scheme. If the employee benefit trust ("EBT") already owns enough shares, the answer may be relatively straightforward.

But suppose it does not.

New shares may need to be issued. That may require the company to fund the EBT, the trustee to subscribe for shares, those shares to be allotted and issued, the appropriate name to be entered in the register of members and the shares to be credited to the relevant custody account. The trustee of the EBT may then hold those shares as nominee or bare trustee for the participants before they are transferred to the bidder under the scheme.

To effect this, the target needs to fund its EBT so that the trust can use those funds to subscribe for the shares required to satisfy vested awards and in order for the resulting shares to be accepted into the trust's custody arrangements. The subscription and associated instructions are then made conditional on Court sanction of the Scheme.

None of those steps is particularly unusual in isolation. The challenge is making them operate as one synchronised settlement process.

The legal timetable and the operational timetable are not the same thing

A scheme contains obvious legal milestones: 

1. Court sanction of the Scheme and delivery of the Court order.
2. The Scheme Record Time.
3. The Effective Date.

Share-plan settlement creates another timetable underneath those events.

Typically, exercise notices for relevant option awards will be conditional on Court sanction. The remuneration committee will determine the vesting outcome and approve the associated share issuance, EBT and payment arrangements. 

The settlement documentation then provides that, following Court sanction, the trustee subscribes for the required new shares to satisfy the option awards. Those shares needed to be allotted and issued and, crucially, credited to the EBT's custody account before the Scheme Record Time. Only then would the shares sitting in that account participate in the scheme and transfer to the bidder. 

This is where the distinction between legal entitlement and operational delivery becomes important.

Saying that an award “vests on Court sanction” tells you what happens to the award. It does not, by itself, tell the registrar or custodian what needs to happen to the resulting shares.

Follow the share, then follow the money

Once the share movement has been mapped, the same exercise needs to be undertaken for the cash.

The takeover consideration attributable to shares delivered in satisfaction of employee awards may need to pass through several hands before reaching participants.

In the structure we recently worked with, the trustee directed the receiving agent to pay the consideration attributable to the relevant shares to the custodian. The custodian was then directed to pass that amount to the target, which received it as agent for the trustee. The target could then account for applicable employment taxes and other permitted deductions before paying the resulting net amounts to participants through payroll. 

That structure joined together several relationships which can otherwise be considered separately:

Trustee → receiving agent → custodian → target/payroll → participant.

The direction of travel matters. So does legal capacity. It is important that each of those parties understands the basis on which each of them send and / or receive the consideration amounts.

In this case where the receiving agent pays the custodian, and the custodian then pays the company, each party needs an instruction that matches the actual movement of cash. That typically takes place through a payment direction letter - which effectively sets out the parallel share settlement and cash consideration transfer processes and ensures that each party is aligned with their responsibilities during the completion process.

Bank account verification is an integral part of any custodian or receiving agent's responsibilities during this process. They will want to ensure that the monies are credited as received in the correct bank accounts at each step of the consideration transfer mechanism. A perfectly drafted settlement structure is of limited use if, on the critical day, one party is still waiting for verified payment instructions.

One number needs to survive several systems

There is a further problem hiding underneath all of this: reconciliation of the shares and the consideration.

The same underlying employee entitlement may appear in several places:

• the share-plan records;
• the final participant allocation schedule;
• the company's register of members;
• the custodian's records;
• the receiving agent's settlement process; and
• payroll.

Those records may describe different stages of the same process, but ultimately they need to reconcile.

Our recent settlement documentation expressly required the parties to reconcile discrepancies between the shares registered in the custodian's name at the Scheme Record Time, the consideration passing through the custody arrangements, the final participant allocation schedule and payroll records. It also provided a process for correcting identified underpayments or overpayments. 

That is more than administrative housekeeping.

If the participant schedule says that an individual is entitled to one number of shares, but the number fed into the share issuance, custody or payroll process is different, the consequences flow directly into the consideration paid, and potentially the tax accounted for.

The participant schedule can therefore become one of the most important working documents in the settlement process. It is the bridge between the legal award, the share entitlement, the scheme consideration and the payroll outcome.

Treat settlement as a workstream, not the final step

The temptation with a takeover is to treat implementation as something to address once the difficult questions about vesting and discretion have been resolved. That is often too late.

The better approach is to design the settlement process backwards from the Scheme Record Time and Effective Date. Map the journey of a single share from the award through to the bidder and then map the corresponding cash from the bidder through to the participant.

For each movement, ask:

Who owns the asset? Who holds it? Who is being instructed? What document gives that instruction? What event triggers it? And what needs to have happened immediately beforehand?

That exercise tends to expose the interfaces early - between the company and trustee, trustee and custodian, company and registrar, registrar and receiving agent and ultimately the transaction settlement process and payroll.

It also identifies which documents need to become effective automatically when a transaction milestone occurs. Transactionally, the trustee's subscription can be expressed conditional on Court sanction, as well as the arrangements for issuing the shares needed to satisfy the awards. 

The objective, though, is really quite simple. At the Scheme Record Time, the right number of shares needs to be in the right place. Following effectiveness, the right amount of cash needs to follow the agreed route. And when payroll runs, each participant needs to receive the correct net amount after the appropriate deductions.

The legal documentation is there to make that sequence happen.

The last 48 hours start much earlier

Perhaps the biggest lesson is that a settlement process which works in the final 48 hours has usually been designed well before them.

The headline decisions on employee incentives may be taken by the board or remuneration committee, but implementation depends on a much broader group: company secretarial and HR teams, payroll, the EBT trustee, custodian, registrar, receiving agent and the legal and transaction teams.

Each sees a different part of the process, and therefore someone therefore needs to see the whole chain.

That may be the less glamorous side of employee incentives on a takeover. But when a Court timetable cannot move and several different organizations need to act in sequence, the mechanics stop being back-office detail and become part of the deal.

At Burges Salmon, we advise listed companies, remuneration committees and transaction teams on the operation and settlement of employee share plans in public M&A transactions, working alongside trustees, registrars, custodians, payroll teams and other advisers to implement award treatment through completion.