Many listed companies are seeking “on-demand” capital solutions that are tailor made to their specific needs. These companies often enter into arrangements with an institutional investor, whereby the company has the right to call specified amounts of cash from the investor against issuance or delivery of a certain amount of shares in return. Such arrangements are often referred to as “equity lines”, “equity distribution agreements” or “share subscription facilities”. This article explores how such agreements are best structured for Swiss listed and incorporated issuers from both a corporate and a capital markets perspective.

By Thomas Reutter / Annette Weber (Reference: CapLaw-2016-18)

1) Standard approach to equity lines in Switzerland

Swiss listed companies wishing to establish an equity line are often referred to alleged “international standard” forms of agreements by potential investors. In fact, there are a few institutional investors, particularly funds, who have invested in companies outside Switzerland and who have allegedly used their “standard form” in doing so. This form usually foresees a right of the company to demand advances in cash from the investor. The consideration of providing cash consists exclusively in shares of the listed company. In the base case scenario, the company issues new shares from authorized capital and delivers them immediately after creation of the shares to the investor in return for the cash received. Alternatively and to minimize the administrative burden that may be related to share creation in certain jurisdictions, the company may only issue shares after several draw-downs of cash. In order to bridge the time gap between cash injection and delivery of shares, another existing shareholder may step in and lend (or occasionally also sell) the shares to the investor on behalf of the company (often referred to as “share provider”). Depending on structure, the share provider either receives shares from the investor once the investor himself receives newly issued shares from the company or it receives shares directly from the company. In the latter case, the company’s delivery of shares discharges the redelivery obligation of the investor in return for the investor waiving to receive shares directly from the company.

The above described arrangements usually also include a cap on the amount the company can draw down, which is set against the backdrop of the liquidity of the respective stock. The price at which the shares are sold is usually at a slight discount of a defined volume weighted average price. Since subscription rights of existing shareholders have be excluded for the purposes of issuing shares to the investor, the consideration received by the company for delivering such shares may not be significantly lower than the “market price” (see below). This price may, however, not necessarily be the same price at which the shares are issued (issue price; Ausgabebetrag).

2) Problems related to share creation and listing

a) Corporate law considerations

Following international precedents, Swiss companies also look to authorized capital as the basket from which to issue shares to satisfy delivery obligations under share subscription facilities. Under Swiss corporate law, authorized capital is an authorization of the board of directors by the shareholder meeting to issue shares during a maximum period of two years and in the maximum amount of 50% of the shares registered in the commercial register. The shareholder resolution needs to be adopted by a majority of two thirds of the votes presented and the absolute majority of the nominal value of the shares presented at such meeting. If adopted, the authorization becomes part of the company’s articles of association.

Authorized capital facilitates the share issuance in that the board of directors rather than the shareholder meeting can implement the actual share issuance. However, a number of drawbacks remain. In order to effect a share issuance out of authorized capital, the subscription amount must be transferred to a blocked account with a Swiss bank. In addition, a notarized deed must be established in the presence of a board member (including an amendment to the articles of association as a result of the higher outstanding number of shares and the reduced number of shares under authorized capital) and a filing needs to be made with the commercial register. Thus, the corporate share creation process out of authorized capital involves a significant amount of paperwork, administrative processes and fees (e.g. notary, commercial register) and is subject to a renewed authorization by the shareholder meeting after two years. The latter implies the risk that a shareholder meeting will not renew the authorized share capital after two years and the company is not able to draw down cash or meet its obligations under a share facility agreement.

b) Capital markets law considerations

In addition to these corporate law steps, a listing application needs to be filed with SIX Swiss Exchange (“SIX”) each time new shares are issued out of authorized capital. According to the listing rules, the Regulatory Board of SIX has principally 20 trading days to review the application. No prospectus needs to be drafted as long as the new shares do not, together with shares already issued in the prior 12 months, exceed 10% of the issued shares. While the filing of the listing application can be timed such as to avoid any delays between share creation and listing, the process as a whole remains burdensome and unsatisfactory for the present purposes.

If the obligation to disclose major shareholdings is triggered (art. 120 of the Financial Market Infrastructure Act (“FMIA”)), the company has to report, inter alia, the number of shares to be delivered under the SSF and to report it as a disposal position in equity securities. The investor has to report the corresponding long position. As the number of shares to be delivered under the SSF depends on the market price of the shares at the time of the exercise, the exact number of shares which will be delivered cannot be calculated. According to guidance by the Disclosure Office of SIX (“DO”), the maximum number of shares which may be delivered has to be reported. This number, however, is a function of the minimum share price which theoretically may be as low as the nominal value. However, in cases of significant discrepancies between the nominal value and the share price, the DO seems to suggest that number of shares can also be calculated according to the current market price of the shares at time of entering into the SSF.

Whenever the investor reaches a reportable threshold in shares as a result of an exercise under the SSF, a new notification has to be made. The company will generally have to update its disposal position if such exercise leads to a crossing of a (lower) threshold. Apparently, the DO wants an updated disclosure notification if the share price significantly increases or decreases (over a certain period of time) provided that a threshold of art. 120 FMIA is reached or crossed as a result of the updated calculation. It is therefore recommended to approach the DO in specific cases and to seek a ruling in order to ensure compliance with the requirements set by the DO.

c) Alternatives to shorten the issuance process: reserve shares

In light of the above shortcomings, some companies have opted to issue shares in advance and well ahead of the time when the delivery obligation arises. Such shares are reserved for the specific purpose of satisfying delivery obligations under a certain instrument such as a share subscription facility (“SSF”) (gebundene Vorratsaktien or “reserve shares”). The process of creating reserve shares is considered permissible by a majority of commentators and has been accepted by commercial registers in practice. In this process, the shares are usually created by a subsidiary of the listed company subscribing them in cash at their nominal value (which is the minimum subscription price). However, it would also be possible, subject to certain limitations, for the company to subscribe for the shares themselves (originärer Erwerb eigener Aktien). Of course, the shares so issued below market price will have to be sold against a market price consideration in light of the fact that subscription rights of existing shareholders must inevitably be withdrawn.

While the creation of reserve shares helps to avoid the multiple replication of the administrative and burdensome tasks related to the creation of shares under authorized capital and related to listing, it has itself substantial shortcomings. Most importantly, shares must be created which may never be used for delivery purposes. Such unused shares will, as a rule, have to be cancelled or offered to all existing shareholders. Such reserve shares will generally be issued at the nominal value. The fair market consideration for such shares will, if at all, only be received by the company at the time of transfer the shares to the relevant third party. Hence, the issuance of such shares will not only be dilutive in terms of number of shares outstanding, but also result in a decreased net asset value per share. The creation in advance of shares potentially needed under the share subscription facility is therefore not an ideal solution either.

3) A new proposal based on conditional capital

a) Characteristics of conditional capital

Conditional capital is a form of capital authorization that enables the board of directors to issue equity linked instruments such as convertible bonds. More precisely, it allows the board of directors to grant conversion or option rights which will trigger the issuance of new shares upon exercise or conversion. Conditional capital has traditionally been used for both capital market instruments and tailor made instruments for specific investors (PIPEs). Like authorized capital, conditional capital needs to be approved by the shareholder meeting with a majority of two thirds of the votes presented and the absolute majority of the nominal value of the shares presented, but unlike authorized capital, it has no statutory limitation on availability. The share creation under conditional capital is straightforward: New shares are created upon payment or declaration to set-off to a Swiss bank. The process obviates the need for a blocked account, a board resolution or a notarial deed for the creation of the new shares, all of which are required for authorized capital. A filing with the commercial register is made only once per year and is merely declaratory in nature, i.e. is not needed to legally perfect the creation of new shares.

The advantages of conditional capital at the level of listing are even more striking. All shares that can potentially be issued under conditional capital can be formally listed in advance with a simple listing application. There is no need to draft a prospectus even if the 10% threshold of existing shares will be exceeded if the shares to be listed are issued in connection with the exercise of rights which are convertible into shares.

b) Use of conditional capital for share subscription facilities

The question therefore arises how a SSF can be designed by using conditional capital instead of authorized capital. The answer is embedded in the purpose of the conditional capital: The SSF has to be structured as an equity linked instrument. In light of the nature of the capital raising, the SSF will also have to be designed as a private investment in a public entity (PIPE) rather than a capital market instrument offered to the public. The host instrument will be a simple credit or loan facility setting out the conditions and process for draw-down of funds. The structure further envisages two conversion rights embedded in the host instrument. On the one hand, the investor has a right to convert the outstanding balance of cash advances previously made. On the other hand, the company has a de facto right to convert as well by forcing conversion by the investor.

The investor’s conversion right is structurally the same as a conversion right in any convertible bond; the only difference relates to the conversion price, which is not predetermined in advance, but will be set in each conversion in relation to the volume weighted share price prior to the conversion declaration and which will also usually be at a slight discount rather than a premium to the share price. In case of a SSF, the share price is obviously a moving target and not frozen at the time of launch of the instrument. Hence, contrary to a traditional convertible instrument, the investor does not realize a capital gain if the share price increases prior to conversion.

The de facto conversion right of the company, however, needs a specific design in order to fit the purpose of conditional capital. Conditional capital pre-supposes a right of the holder of the equity-linked instrument to trigger the share creation. It is unclear if the company can be the beneficiary of such right as well. Most of the commentators limit the beneficiaries to the holders of options and conversion rights, but without any further reasoning. The prudent approach therefore is, in our view, to design the company’s “conversion right” or share settlement option such as to maintain the formal right of the investor to exercise the conversion, but to provide an economically compelling reason for the investor to exercise such right. This can be done by conferring the ability on the company to write-down the outstanding balance of the facility to zero. Prior to such write-down, the investor has the right to exercise conversion, generally at the same terms at which he would otherwise have exercised such right. In order to protect the investor, the terms of the SSF can further provide that the investor is deemed to have converted if no conversion declaration is received during a specified period of time.

4) Challenges and Conclusions

If the parties’ intention is to convert immediately after each draw down the question may be asked whether this would somehow evade the rules of share creation under authorized capital or, conversely, whether the law prescribes a certain minimum term during which a conversion right cannot be exercised. Clearly, there is no minimum “holding” or “non-exercise” period for conversion rights stipulated in any statutory act. Also and to our knowledge, no court precedent or commentator has taken the view that there is such a minimum period for conversion rights. The legislator did not prefer any form of share creation over the other. Indeed, we are not aware of any reason why there should be any legal issue if the share creation under the SSF complies with the requirements for conditional capital even if the parties’ intent was to convert immediately.

A SSF structured as a convertible instrument using conditional capital is essentially a credit facility with share settlement features. In lieu of redemption, the parties agree to convert outstanding debt balances of the company in shares. The right to convert should economically inure to the benefit of both parties whereby in either case the legal right to demand conversion will formally remain with the holder of the instrument (see above). If the SSF is structured as share settled credit facility using conditional capital, the share creation and listing process is substantially easier compared to the traditional approach using authorized capital share creation. Market players should therefore, if investing in Swiss listed companies, rethink their traditional approach and adopt the approach which is better suited in light of the local regulatory framework.

Thomas Reutter (thomas.reutter@baerkarrer.ch)
Annette Weber (annette.weber@baerkarrer.ch)