Vodafone Group Plc, Re Companies Act 2006

At a hearing on 21 February 2014 I sanctioned a scheme of arrangement (“the Scheme”) between Vodafone Group Plc (“the Company”) and its shareholders pursuant to sections 895 to 899 of the Companies Act 2006 (“the 2006 Act”). At a further hearing later the same day, I also confirmed the various reductions of capital contained in the Scheme. In terms of value, the Scheme was one of the largest ever to have come before the court, involving as it did the sale by the Company of its 45% stake in a joint venture with Verizon Communications Inc. (“Verizon”) for a headline consideration of US $130 billion, and a return of value by the Company to its shareholders of approximately US $84 billion. In addition, the detailed terms of the Scheme were of very considerable complexity.

It is a tribute to the care and skill with which the Scheme was devised, drafted and explained to shareholders that it was approved by an overwhelming majority in both number and value of the Scheme Shareholders who participated in the meeting convened by the court under section 896 of the 2006 Act on 28 January 2014 (“the Court Meeting”). Of the 63,491 Scheme Shareholders who participated in the Court Meeting, 62,909 voted in favour of the Scheme and only 582 voted against it. The majority in value of the shares voted in favour of the Scheme was no less than 99.61%. The participating shareholders between them held just under 60% of the Scheme Shares in issue.

At a general meeting of the Company held on the same day, the one ordinary and three special resolutions needed to implement the Scheme and the associated reductions of capital were also duly passed by the requisite majorities.

In the event, there was no opposition at all to the Scheme at the hearing to sanction it on 21 February. I heard submissions from Mr David Chivers QC (leading Mr Andrew Thornton) on behalf of the Company, and from Mr Martin Moore QC on behalf of Verizon. In the circumstances, I had no difficulty in holding that it would be appropriate for the Court to approve the Scheme.

The purpose of the present judgment is to deal with one aspect of the procedure for the reductions of capital which had been debated before me at earlier hearings on 9 December 2013 and 5 February 2014, and which led me at the second of those hearings to make an order dispensing with the settlement of a list of creditors under section 646 of the 2006 Act. Since those hearings, although held in public, had not been advertised, and were more of the nature of unilateral applications for directions by the Company, I think it is appropriate that I should explain the reasoning which led me to dispense with the settlement of a list of creditors, and review at least in outline the main evidence which the Company adduced before me for that purpose.

Before doing so, I will first give an overview of the main features of the Scheme which is largely derived from the helpful skeleton arguments produced by Mr Chivers QC and Mr Thornton for the hearings in December and February.

The issued share capital of the Company consists of ordinary shares of 11 and 3/7ths cents (US) and 7% cumulative fixed rate preference shares of 100p. The Scheme has no impact on the preference shares, which may for present purposes be ignored. The Company’s ordinary shares are traded on the London Stock Exchange.

The Company also has an American Depositary Receipt programme administered by Bank of New York Mellon (“BONY”). Under this programme, approximately 20.37% of the Company’s outstanding ordinary shares are deposited with BONY in its capacity as depositary (every 10 such ordinary shares constituting an “American Depositary Share”, or “ADS”, and the physical certificate representing them being an “American Depositary Receipt”, or “ADR”). ADSs are listed and traded on the New York Stock Exchange. BONY is the legal owner of the ordinary shares referable to the ADR programme.

Prior to the Scheme, the Company had two joint interests with Verizon. The first was the business of Verizon Wireless, operated by a Delaware partnership indirectly owned as to 45% by the Company and 55% by Verizon. The second was the business of Vodafone Italy, operated by a Dutch company which was indirectly owned as to 76.9% by the Company and 23.1% by Verizon.

On 2 September 2013, the Company announced that it had reached an agreement whereby it would sell to Verizon its 45% stake in Verizon Wireless (“the VZW Transaction”) and would buy from Verizon its 23.1% interest in Vodafone Italy (“the Vodafone Italy Transaction”) (together, “the Transactions”).

The terms of the VZW Transaction were set out in a stock purchase agreement entered into on 2 September 2013 between the Company, Verizon and the vendor company, Vodafone 4 Limited (“V4L”). The terms of the Vodafone Italy Transaction were set out in another share purchase agreement of the same date. Completion of the Vodafone Italy Transaction was conditional upon completion of the VZW Transaction, but not vice versa. If, however, the VZW Transaction did complete, the Vodafone Italy Transaction was expected to complete simultaneously.

The headline consideration due from Verizon in respect of the Transactions was US $130 billion, to be settled as follows:

It was further proposed that the Company would return approximately US $84 billion of the net proceeds from the Transactions to shareholders by means of the Scheme (“the Return of Value”). The number of Verizon Consideration Shares to be issued to the Company’s shareholders was to be determined (subject to adjustments in certain circumstances) by dividing the headline figure of US $60.15 billion by the “Adjusted Closing Price”. The Adjusted Closing Price was the volume-weighted trading price of Verizon’s common stock on the New York Stock Exchange during a measurement period of 20 trading days ending on the third business day before the date on which the Scheme became fully effective, but subject to a minimum of US $47.00 and a maximum of US $51.00.

At the time of the announcement on 2 September 2013, and based on exchange rates then current, the expected Return of Value was equivalent to 112p per ordinary share, representing 71% of the net proceeds from the Transactions and approximately 54% of the Company’s market capitalisation based on the then share price of 206p. Accordingly, the Company also announced that it would undertake a consolidation of its ordinary share capital following the Return of Value with a view to maintaining broadly the same price of its shares before and after the Return of Value (“the Share Consolidation”).

By the time of the hearing on 5 February 2014, changes in exchange rates and share prices meant that the expected Return of Value was then equivalent to approximately 103p per ordinary share, representing approximately 46.25 % of Vodafone’s current market capitalisation based on a share price of 223p.

The purpose of the Scheme was to implement and give effect to the VZW Transaction, the Return of Value and the Share Consolidation. The VZW SPA expressly provided for completion of the VZW Transaction to occur in accordance with the Scheme, but it also provided for completion to take place if the Scheme were withdrawn or failed to become effective, subject to the satisfaction or waiver of certain other conditions.

The mechanics of the Scheme involved a number of steps, intended to follow each other in rapid succession on the same day (expected to be Friday, 21 February 2014, as in fact happened):

Following the cancellation of the B Shares, the capital paid up on them would be repaid to the holders, such repayment to be settled in part by the Company paying a cash sum to the holder in respect of each B Share (“the Cash Entitlement”) and in part by Verizon issuing the relevant number of Verizon Consideration Shares. A special dividend would at the same time become payable on the C Shares, to be settled in part by the Company paying a cash sum equal to the Cash Entitlement to the holder, and in part by Verizon issuing the balance of the Verizon Consideration Shares, the number of such shares to be received in respect of each C Share being the same as the number received in part satisfaction of the repayment of capital on a B Share. The Company would also become obliged to issue and deliver two promissory notes to V4L, in an aggregate amount equal to the market value of the Verizon Consideration Shares issued to the holders of the B Shares and the C Shares. Finally, the Share Consolidation would become effective in accordance with a ratio reflecting the proportion that the Return of Value bore to the market capitalisation of the Company shortly before the Scheme became fully effective.

As can readily be imagined from the above summary, the Scheme Document was a lengthy one, running to over 150 pages of small print. It included, in the usual way, an explanatory letter from the Chairman of the Company, Mr Gerard Kleisterlee, and a detailed explanatory statement, as well as the proposed text of the Scheme itself.

Since all the Scheme Shareholders were being offered the same deal, it was clearly appropriate (in accordance with settled authority) that there should be a single meeting of all the Scheme Shareholders on the footing that they were all members of the same class, whose rights were sufficiently similar for them to be able to consult together with a view to their common interest: see Re Sovereign Life Assurance Co v Dodd[1892] 2 QB 573. I gave directions to this effect at the first hearing on 9 December 2013.

The purposes of the proposed reductions of capital were essentially twofold: first, to enable and fund a substantial part of the Return of Value; and, secondly, to leave the Company, after the Scheme had been implemented, with a level of distributable reserves comparable, on a per share basis, with that which existed before the Scheme took effect.

Under section 646(1) of the 2006 Act, a creditor (which for this purpose means anyone who would be entitled to prove in a hypothetical winding up of the company, and so includes contingent or prospective creditors) is entitled to object to a proposed reduction of capital if he can show a “real likelihood” that the reduction would result in the company being unable to discharge his debt or claim when it fell due.

The main relevant provisions of the 2006 Act read as follows:

The “real likelihood” test in section 646(1)(b) was introduced with effect from 1 October 2009 by regulation 3 of the Companies (Share Capital and Acquisition by Company of its Own Shares) Regulations 2009, SI 2009/2022. There is still relatively little authority on the interpretation of the test. The leading case is the decision of Norris J in Re Liberty International Plc[2010] EWHC 1060 (Ch), [2010] 2 BCLC 665. The guidance which Norris J gave in that case has subsequently been followed and applied in two Scottish cases, Re Royal Scottish Assurance Plc[2011] CSOH 2, 2011 SLT 264 and Re Sportech Plc[2012] CSOH 58, 2012 SLT 895.

In Liberty International, Norris J said this:

The evidence adduced before Norris J included a working capital model which addressed the claims of both assenting and non-assenting creditors over a period of about 18 months until December 2011. Norris J said at [21]:

The Royal Scottish Assurance case concerned a company which had originally been formed as the vehicle for a joint venture with The Scottish Equitable Life Assurance Society Ltd. After the termination of that joint venture, the company was used as the vehicle for further joint ventures between the Bank and two other companies providing life assurance and pension products, first Scottish Widows and then Aviva Plc. The court was asked to confirm the reduction by £90 million of the company’s share capital, as part of a proposed return of capital to the joint venture partners.

After setting out the relevant statutory provisions, Lord Glennie recorded in [8] that no list of creditors had been settled under section 646 or its predecessors either in Scotland or in England since 1949. He explained that the requirement for a list of creditors has always been disapplied, and the court has adopted a variety of methods to ensure that the interests of any creditor put at risk by the reduction are protected. Lord Glennie identified the main such methods as:

None of those methods was being offered in the instant case, so Lord Glennie went on to consider whether the court could safely dispense with the settling of a list of creditors on the footing that the “real likelihood” test was not satisfied. After referring to Liberty International, and quoting paragraphs [16] to [20] of Norris J’s judgment, Lord Glennie continued in [12]:

The latest audited accounts of the company showed a healthy financial position, but as Lord Glennie observed at [15] they provided little assurance for policyholders whose entitlement might only accrue some 20 or more years in the future. He was nevertheless satisfied that there was no realistic possibility of any such policyholder being able to satisfy the “real likelihood” test, having regard to the regulatory position under which the company carried on business. After giving details of the relevant regulatory provisions, Lord Glennie said at [22]:

In the Sportech case, a holding company applied for an order confirming the cancellation of its share premium account, which had a credit balance of some £20.7 million, in order to make that amount available for distribution as future dividends. In considering the question of creditor protection, Lord Hodge endorsed the three points made by Norris J in Liberty International, and agreed with Lord Glennie in finding Norris J’s guidance helpful. He also agreed with Lord Glennie that “the creditor must show the real likelihood of a causal link between the reduction of capital and the company’s inability to discharge his debt”: see his judgment at [12]. He went on to say that the company had provided sufficient information about its future cash flow to enable him to conclude that there was no real likelihood of prejudice to non-consenting creditors: see [16] to [21].

In the light of the guidance given by these authorities, Mr Chivers QC for the Company sought a non-binding preliminary indication from the court at the first hearing on 9 December 2013 about the nature and quality of the evidence which was likely to be acceptable to the court in deciding whether it could dispense with settlement of a list of creditors. In particular, counsel wished to explore with me the extent to which the Company in its evidence could maintain confidentiality with regard to commercial or market sensitive information, while providing the court with information which would be sufficiently robust to justify dispensing with a list of creditors.

Despite some initial doubts on my part, this proved to be a worthwhile and helpful exercise. Mr Chivers outlined the categories of evidence which the Company proposed to adduce. He suggested, and I provisionally agreed, that the Company would produce a cash flow forecast for three years, in addition to the working capital statement for the next 12 months that it was anyway necessary to include in the Scheme Document. A three year forecast would be double the length of the one provided to Norris J in Liberty International, and could be based on existing information without descending into the realms of speculation. Mr Chivers submitted, however, that it would not be sensible to try to provide forecasts further into the future, both because the exercise would become inherently speculative and because it is hard to conceive how, at such a distance of time, a creditor could establish the necessary causal link between the proposed reduction of capital and inability to pay his debt. Again, I agreed with this approach.

Mr Chivers’ suggestion for protecting confidentiality and market sensitive information was that the three year forecast should deliberately be prepared on the basis of over-pessimistic assumptions, which would nevertheless reflect and take as their starting point the existing assumptions which lie behind the 12 month working capital statement. In this way the Company would not be obliged to disclose the actual assumptions which it was in fact using to plan its business operations over the next three years, because those assumptions would be market sensitive and of potential value to competitors. The court would also have the comfort of knowing that there would be an additional margin of safety if the position appeared to be satisfactory even on the basis of the Company’s deliberately over-pessimistic forecasts. This seemed to me an imaginative and ingenious solution to the problems potentially posed by issues of confidentiality and market sensitivity, and I indicated that I was provisionally content with it.

The further evidence adduced by the Company for the purposes of the hearing on 5 February 2014 was contained in the second witness statement of Andrew Halford, the chief financial officer and a director of the Company, and in the exhibits thereto. The longer-term cash flow forecasts were set out in a document covering the period to 31 March 2017. As Mr Halford explains in paragraph 101 of his statement, they were prepared “not on the basis of an expected outturn, but instead to reflect a more conservative scenario in order to demonstrate a sufficient margin of safety from the perspective of creditors”. Accordingly, they reflected more conservative assumptions about the future trading performance of the Group’s business than those reflected in the working capital statement contained in the Scheme Document.

Mr Halford gives evidence of the process by which the working capital statement in the Scheme Document was produced. The inclusion of such a statement in the Scheme Document is a requirement of the Listing Rules of the Financial Conduct Authority (“FCA”), in its capacity as the United Kingdom Listing Authority. Its preparation requires the most careful consideration of the group’s own cash flow forecasts, by both the Company and its advisers, taking into account regulatory requirements, guidance published by the FCA, and the custom and practice of the City. The cumulative effect of these constraints, says Mr Halford, is that “there is effectively no margin for error”.

In a little more detail, the Company prepared monthly cash flow forecasts for the period to 31 March 2015 on the basis of the latest available internal cash flow forecasts for that period, taking account of the current and expected trading performance of the underlying business, other cash inflows and outflows expected to occur during the period, and the servicing of group debt. The forecasts were accompanied by a sensitivity analysis designed to satisfy the Company’s board, the reporting accountant (Deloitte LLP) and the Company’s sponsors for the purpose of the Listing Rules (UBS and Goldman Sachs) that working capital was expected to be sufficient even in a reasonable “worst case” scenario. Out of an abundance of caution, the forecasts and Deloitte’s report were in fact prepared for a period of 16 months. It was also assumed that no refinancing of existing facilities would be undertaken during the period, and that no cash generated by operations of the Company’s subsidiaries would be available if it were not readily available for distribution.

The cash flow forecasts prepared by the Company were then reviewed and challenged by Deloitte, UBS and Goldman Sachs in their respective roles as reporting accountant and joint sponsors under the Listing Rules. Deloitte produced a working capital report, and also issued a private comfort letter to the board stating their opinion that the board had a reasonable basis for making the working capital statement, and that it had been so made after due and careful enquiry. For their part, UBS and Goldman Sachs provided a similar formal confirmation to the FCA. Guidance published by the FCA states that a sponsor is expected to apply its own judgment, experience, knowledge and expertise when deciding whether a listed company has a reasonable basis on which to make the working capital statement, and to fulfil this function a sponsor must itself review and challenge the work done by the company and reporting accountant.

Mr Halford also explains that the Vodafone group has a head-office team dedicated to the maintenance of a forecasting model for business planning purposes. The team is headed by two accountants with extensive experience of the group’s structure and the wider issues facing the telecommunications sector.

At the hearing on 5 February, Mr Chivers took me through much of the material which I have summarised above. He referred to the FCA’s Technical Note on working capital statements and risks factors, and emphasised that such a statement normally has to be provided on a “clean” basis, that is to say without qualification and founded on reasonable assumptions. He invited me to accept Mr Halford’s assessment that the preparation of a working capital statement is subject to so much regulation, and so many checks and balances, that in practice it leaves no margin for error. I would not go quite that far, but I certainly accept that the process is an extremely rigorous one, with the result that the unqualified statement provided by the Company for the purposes of the Scheme provides a sound and reliable basis for longer term forecasts.

Mr Halford discusses the main classes of the Company’s creditors, and exhibits a tabular analysis with supporting notes. The analysis shows the Company as having external creditors shown on the balance sheet of £25,932 million, intra-group creditors of £105,014 million, and off-balance sheet creditors of £5,385 million. The off-balance sheet items relate to pension fund guarantees, counter indemnities and performance bonds. Of the sums due to external creditors, about one third fall due for repayment within one year, and two thirds fall due thereafter. In particular, the bulk of the Company’s outstanding bond issues fall due for repayment after one year. Conversely, the position on intra-group debt is that the sums owed to the Company exceed the creditors by £52,725 million, all of it falling due within one year.

For present purposes, the most significant of the Company’s creditors are the holders of its publicly traded bonds. These have maturity dates ranging from June 2014 to February 2043. They represent a form of quasi-permanent capital, which the Company intends to refinance as and when they fall due (if not earlier). The ability of the Company to refinance its bonds is fully addressed in the evidence, and I see no reason to doubt the Company’s confidence that it will continue to be able to do so for the foreseeable future. It is worth quoting what Mr Halford says on this subject:

The Company’s ability to refinance its bonds and bank facilities is also supported by the opinions of UBS and Goldman Sachs.

The Company has commercial paper outstanding of £5,086 million. Mr Halford explains that the Company’s commercial paper programmes are supported by committed loan facilities of $4.2 billion and €4.2 billion, respectively, provided by a syndicate of banks. The intention is that these facilities will not be drawn, but they are available in the unlikely event that outstanding commercial paper could not be refinanced by the issuing of fresh commercial paper. Equivalent facilities have been in place for over 15 years, but have never been drawn.

The Company has nine fully drawn bank loans, with an aggregate principal amount outstanding of £3,054 million owed to five counterparties with maturity dates between 2014 and 2020. All of the banks are participants in the syndicated facilities which I have mentioned in connection with the Company’s commercial paper programmes, and they have all consented to the reduction of capital.

The Company has also entered into various hedging arrangements, which can move in or out of the money depending on moves in interest rates and foreign exchange rates. As at 31 December 2013, the Company was a net creditor of its various counterparties in the aggregate amount of £1,562 million. Ignoring the contracts in respect of which the Company was in the money, the total amount owed to counterparties by the Company was £1,939 million. That is the sum treated as due under the creditor profile exhibited by Mr Halford, despite the net positive position, rights of set-off held by the Company and cash collateral posted by the Company to support those liabilities. This is just one example of the deliberately conservative assumptions which the Company has made in assessing its cash flow requirements.

The last audited financial statements of the Vodafone group for the year to 31 March 2013 show that the Company had shareholders’ funds of £92,391 million. The corresponding unaudited figure as at 31 December 2013 was £89,073 million. The evidence includes a pro forma balance sheet showing the impact of the proposed capital reduction and Return of Value. This shows that on completion of the exercise the Company will still have equity shareholders’ funds of £36,006 million. By any normal standards, therefore, it will remain hugely solvent.

I have already described the working capital forecast contained in the Scheme Document. The position disclosed by the deliberately conservative cash flow forecasts to 31 March 2017 is no less reassuring. According to these forecasts, the group is estimated to produce “free cash flow” well in excess of £3,000 million in each of the four financial years from 2013/14 to 2016/17. The forecasts define “free cash flow” as meaning:

In his evidence Mr Halford also deals with various matters and potential claims which are not included in the creditor profile, on the basis that the Company does not consider that it has any relevant liability which has not already been taken into account. It is unnecessary for me to review this evidence in detail. In summary:

The evidence which I have so far reviewed constitutes the core material on the basis of which the Company submitted I could be satisfied that no creditor would be able to satisfy the “real likelihood” test. As further support for this conclusion, I was referred to evidence showing that neither the main rating agencies (Fitch, Moody’s and Standard & Poor) nor the bond and credit default swap markets had reacted negatively to the proposals. The long term credit ratings assigned by the three agencies to the Company did not change following the announcement of the Transactions and the proposed Return of Value, and maintained their existing “A” status, denoting expectations of low default risk. Mr Halford points out that, in forming their views, the agencies are not confined to publicly available information, but also have access to information similar to that reflected in the Company’s short term and long term cash flow forecasts. Furthermore, even after the Return of Value, the Vodafone group’s net debt/EBITDA (earnings before interest, taxation, depreciation and amortisation) ratio will continue to compare very favourably with that of its global telecom peer group. The Company’s bonds are publicly traded, as are its credit default swaps. The evidence indicates that the market’s view of the Company’s creditworthiness has not been adversely affected by the proposals.

Finally, most of the Company’s bank lenders have signed letters confirming that they have no objection to the Return of Value.

On the strength of all this evidence, and with the benefit of Mr Chivers’ patient and expert guidance through the exhibits, I was fully satisfied at the hearing on 5 February 2014 that there was no realistic possibility that any creditor of the Company, present or future, would be able to satisfy the “real likelihood” test within a time frame where such an assessment could sensibly be made. I therefore agreed to dispense with settlement of a list of creditors under section 646 of the 2006 Act.

By way of postscript, I should also mention that at the hearings to sanction the Scheme and confirm the reductions of capital on 21 February 2014 I was informed of two recent developments which might have some impact on the cash flow forecasts which I had considered at the previous hearing. The first was the possible acquisition by the Company of an unlisted Spanish business, Ono. I was told that any such acquisition would be for a fair price, reflecting Ono’s incremental contribution to the group’s assets, EBITDA, cash flows and growth opportunities. The second related to the dispute with the Indian tax authorities, where it appeared that efforts to reach a negotiated solution had reached a deadlock. Thus the prospect of VIH BV having to pay a substantial deposit into court pending resolution of the group’s claim under the bilateral investment treaty had become more likely, with an immediate cash outflow estimated not to exceed £800 million.

I was satisfied, on the basis of a third witness statement from Mr Halford, that even after the Return of Value the Company would, if necessary, be well able to finance both the Ono acquisition and the cash flow consequences of the Indian tax claim. Even if both contingencies were to materialise, the group’s consolidated net debt/EBITDA ratio would probably rise to about 1.5, which would still be substantially lower (and thus stronger) than the Company’s own average over the last four years of approximately 2x, and could still be comfortably financed on a sustainable basis, even allowing for planned increases in capital expenditure and the intended programme of distributions to shareholders. As before, the markets had also shown themselves unperturbed by the possible impact of the Ono acquisition and the Indian tax claim.

I therefore saw no reason to alter the conclusions which I had reached on 5 February.