Wolfgang Amadeus Mozart, GC of your good foreign private issuer client Falco AG is calling. Falco has failed to break out internationally, despite one product that has been a major hit around the world, and has decided to reorganize its international operations held through a Bermuda holding company.

Mozart tells you that the Bermuda company has US minority shareholders and that the Bermuda lawyers are planning to use something called a “scheme of arrangement” to exchange shares in the existing Bermuda company for shares in a new entity. “Do I need to register the exchange with the SEC?” he asks. Here is the answer that will rock Amadeus.
Schemes of Arrangement and Section 3(a)(10)

By way of background, a scheme of arrangement is a flexible tool for court-approved corporate reorganizations found in the law of a variety of jurisdictions (including the UK, India, Australia and South Africa).

Section 3(a)(10) of the Securities Act provides an exemption from Section 5 that works well for schemes of arrangement. In particular, Section 3(a)(10) exempts securities issued outside the context of federal bankruptcy proceedings “in exchange for one or more bona fide outstanding securities, claims or property interests, or partly in such exchange and partly for cash, where the terms and conditions of such issuance and exchange are approved, after a hearing upon the fairness of such terms and conditions at which all persons to whom it is proposed to issue securities in such exchange shall have the right to appear, by any court, or by any official or agency of the United States, or by any State or Territorial banking or insurance commission or other governmental authority expressly authorized by law to grant such approval.”
Staff Legal Bulletin No. 3A

The SEC Staff explained the requirements for Section 3(a)(10) exchanges approved by a court in SLB 3A, as follows:

• The securities must be issued in exchange for securities, claims, or property interests; they cannot be offered for cash.
• A court or authorized governmental entity must approve the fairness of the terms and conditions of the exchange.
• The reviewing court or authorized governmental entity must: Find, before approving the transaction, that the terms and conditions of the exchange are fair to those to whom securities will be issued; and be advised before the hearing that the issuer will rely on the Section 3(a)(10) exemption based on the court’s or authorized governmental entity’s approval of the transaction.
• The court or authorized governmental entity must hold a hearing before approving the fairness of the terms and conditions of the transaction.
• A governmental entity must be expressly authorized by law to hold the hearing, although it is not necessary that the law require the hearing.
• The fairness hearing must be open to everyone to whom securities would be issued in the proposed exchange.
  Adequate notice must be given to all those persons.
• There cannot be any improper impediments to the appearance by those persons at the hearing

Is Section 3(a)(10) available for a non-US court proceeding?

Yes. In SLB 3A, the Staff took the position that the Section 3(a)(10) exemption is available in connection with proceedings in foreign courts. For the Staff to issue a no-action letter in these situations:

• All the requirements applying to US exchanges must be met; and
• Counsel licensed to practice in the foreign jurisdiction must provide a legal opinion stating that the foreign court is required to approve the fairness of the proposed exchange to the recipients of securities before the court can approve the transaction.

Recall that Falco is looking to reorganize via a Bermuda scheme. In 2009, the SEC Staff issued a no-action letter (Weatherford International Ltd.) regarding a reorganization effected through a scheme of arrangement under Section 99 of the Companies Act of 1981 of Bermuda. While no-action letters are, as a formal matter, limited to specific parties (and specific facts) it is not uncommon to proceed with non-US Section 3(a)(10) transactions pursuant to a scheme without a separate no-action letter if the facts of a given transaction are squarely within prior no-action precedent in the relevant jurisdiction. If you find yourself in that situation, let’s talk.
Some additional points to note about Section 3(a)(10)

• Securities issued in a Section 3(a)(10) exchange are generally not considered “restricted securities” subject to US resale limitations, unless the recipient is an “affiliate” of the issuing company (or was one within the prior 90 days).
• Section 3(a)(10) exchanges are subject to the blue sky laws, so you will want to conduct a blue sky survey to determine the residency of current holders of Bermuda stock and to identify applicable state exemptions.
• Section 3(a)(10) is not available for securities issued outside the court proceeding (e.g., securities separately issued to shareholders).
• Potential anti-fraud liability applies to disclosure documents provided to US securityholders in connection with the Section 3(a)(10) exchange.