The right for a shareholder of a company to bring an action for unfair prejudice has been the subject of many cases over the years. This right allows a shareholder to bring an action on the ground that:

- the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of the members generally or some part of its members (including at least himself); or

- an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.

A member of a limited liability partnership (LLP) is also entitled to bring an action for unfair prejudice but, as the LLP is a relatively new form of legal entity, there is limited case law on unfair prejudice actions in respect of LLPs.

Case

A recent case has considered a number of preliminary issues in an action alleging unfair prejudice in a LLP. The judge answered the preliminary issues in favour of the member bringing the action. The judge’s comments included:

- as there was no written LLP agreement, there was no express power to expel a member;

- despite one of the members considering himself as the “boss”, in the absence of a written LLP agreement, he was not entitled to a higher return; and

- the exclusion of a member from the management of the LLP was one of the clearest examples of unfairly prejudicial conduct.

Comment

This case is interesting because it shows the application of an unfair prejudice action in the context of a LLP.

The case also highlights the importance for the members of a LLP to put a written members’ agreement in place. Without a written agreement, default statutory provisions will apply to the LLP which means, for example, that all members are entitled to an equal share of profits and to be involved in the management of the LLP. It is unlikely that such default provisions will be appropriate for all LLPs. It is also possible for a members’ agreement to disapply the statutory right for a member to bring an unfair prejudice action.

Eaton v Caulfield [2011] B.C.C. 386

The Companies Act 2006 sets out a director’s fiduciary duties in statute for the first time. These include duties:

- to promote the success of the company;

- to avoid conflicts of interest; and

- not to accept benefits from third parties.

Case details

A director acquired equipment for his personal use by way of a free, undisclosed and unapproved loan from one of the company’s customers. At the initial hearing, the judge held that the director had acted in breach of his fiduciary duties.

Decision

On appeal, the judge considered various defences put forward by the director such as the absence of evidence that the company had suffered any loss or that the director had any corrupt motive and the fact that the value of the benefit to the director was small. However, the judge dismissed such defences and upheld the initial decision.

Comment

This case shows that the courts take a strict view of any breach of directors’ duties and even a breach with a small financial value can lead to a director being found liable.

Philip Towers v Premier Waste Management Ltd [2011] EWCA Civ 923

When a buyer purchases a business, it usually wishes to ensure that the seller cannot compete with the business of the target post-sale. We therefore recommend that restrictive covenants are included in any sale and purchase agreement.

Facts of the case

In this case the restrictive covenants in the sale and purchase agreement included a non-solicitation clause which prohibited the defendant from soliciting, canvassing or enticing away the customers of the target business for three years following completion. Before that three year period ended, the claimant noticed that some of its clients were moving to the firm where the defendant now worked. Clients had never moved to that firm before and the claimant issued proceedings for breach of restrictive covenant by the defendant.

Decision

The High Court ruled that the restrictive covenant had been breached due to the defendant’s actions and intentions on the following ground that the evidence showed that:

- there was a secret intention between the defendant and his new employer of an intention to acquire the claimant’s client base and a clear intention of the defendant to solicit the claimant’s clients for his new employer; and

- there were a number of clear actions by the defendant which solicited the clients for his new employer, including calling and meeting clients and encouraging them to follow his move.

The High Court considered that no client could have been guaranteed to stay with the claimant firm for more than one year but ruled that damages should be payable to reflect that one year’s revenue, such that the defendant was liable to pay damages of £31,875.

Comment

This case shows the importance of putting restrictive covenants into a sale and purchase agreement. Restrictive covenants must be very carefully drafted so as to be reasonable when considering their length, geographical effect and scope, and are interpreted on a case-by-case basis by the court, but this case highlights that time spent drafting such provisions can be time well spent.

Baldwins (Ashby) Ltd v Maidstone

For advice on directors’ duties please contact Emma Cameron or any other member of our Corporate Team.

The amendments include:

- no longer having to state whether the company was a traded company at any time during the return period;

- when describing a company’s principal business activity, the classification scheme that companies may use is the 2007 edition of the UK Standard Industrial Classification of Economic Activities (rather than the 2003 edition); and

- requiring the annual return to state whether any of the company’s shares were, at any time during the return period, admitted to trading on a “relevant market” which, for example, would include the London Stock Exchange’s main market, AIM and regulated markets outside the UK.

The regulations setting out these amendments are currently in draft form but it is intended that they will come into force on 1 October 2011 and apply to returns made up to that date or a later date.

The Government announced in August 2010 that it had asked Lord Davies of Abersoch to develop a strategy to address concerns that there are too few women on the boards of UK listed companies. The “Women on Boards” report has now been published.

Recommendations

The report does not propose statutory quotas as a way to incease female board representation but instead makes several “business-led” recommendations such as:

- the target percentage representation of women on the boards of FTSE 100 companies should be 25%;

- a voluntary code of conduct should be drawn up by headhunting firms to address gender diversity for the boards of FTSE 350 companies;

- disclosure requirements for quoted companies should be introduced (so that a quoted company must disclose the proportion of women on its board, the number of women in senior executive positions and its total number of women employees);

- a deadline of September 2011 should apply to FTSE 350 companies to announce their targets for female board representation; and

- companies should advertise their non-executive positions from time to time to encourage a wider range of applications.

If these recommendations do not result in a significant increase in female board representation for UK listed companies, the Government may yet introduce statutory quotas.

Disclosure obligations

The Disclosure and Transparency Rules (DTR) apply to companies which are listed on a regulated market in the UK. The Listing Rules (LR) apply to companies which are listed on the FSA’s Official List. The DTR and LR impose certain obligations on such companies, including the way in which inside information should be controlled and disclosed. This is to ensure that all of the users of the markets receive the same information at the same time.

As JJB is a FTSE listed company it is subject to the DTR and LR.

Facts

JJB acquired OSC on 18 December 2007 for £5 million but did not disclose that it was also to purchase the in-store stock at a price of £10.038 million. On the later acquisition of Qube on 22 May 2008 for the nominal sum of £1, JJB failed to disclose the fact that it was in addition settling Qube’s overdraft facility at a cost of £6.47 million.

It was only later on 26 September 2008 when JJB published its interim results that it disclosed the true costs of the acquisitions for the first time, resulting in its share price falling by 49.5%.

FSA decision

The FSA considered that JJB’s failure to disclose the true costs of the acquisitions had created a false market in JJB’s shares for over nine months. The true costs constituted inside information and the information was that which a reasonable investor would use to reach investment decisions. JJB had therefore failed to comply with the DTR and LR.

The FSA originally imposed a penalty fine of £650,000 which was later reduced to £455,000 as a result of JJB’s cooperation in quickly reaching a settlement. This sum is the second largest fine the FSA has imposed for a breach of the DTR and LR.

The Government issued a review on this topic in December 2010. More than 2,600 responses to the review have been received. Meetings have also been held with a number of interested groups which have generated suggestions such as trial periods on company boards and widening the talent pool by allowing recruitment from the services sector. Lord Davies is heading the review and will make his recommendations to the Government this February.

The CBI has responded to the Government’s review by stating that the UK Corporate Governance Code should require listed companies to report on diversity on a “comply or explain” basis. This would force listed companies to set internal targets and, if such targets are not met, provide a report setting out the reasons why. Companies would be able to take their particular circumstances into account when setting the targets so that, for example, a media company with lots of female employees would set higher targets than an engineering company with few female employees. A similar scheme due to be introduced in Australia next year has reportedly already caused an increase in the number of female board appointments. It will be interesting to see if any changes introduced in the UK have a similar effect.

BAE Systems plc (BAE) and the Serious Fraud Office (SFO) reached a settlement agreement in February 2010 as regards BAE’s alleged corruption in the procurement by BAE of a contract with the government of Tanzania. The settlement with the SFO was the result of co-ordinated action with the US Department of Justice.

Since the settlement with the SFO, some court cases have questioned the ability of the SFO to conclude settlements. Judges in two such cases stated that the courts could not be bound by such settlements and the SFO may only suggest a sentencing range, rather than specific sentences. The outcome of the BAE court case has therefore been eagerly anticipated.

Decision

BAE was sentenced on 21 December 2010 after pleading guilty to failing to keep adequate accounting records contrary to the Companies Act 1985.  The guilty plea formed part of the settlement which BAE had reached with the SFO. The judge stated that although he was not bound by the settlement, he accepted the basis of the plea itself.

Comment

The case will be of interest to companies considering self-reporting to the SFO for corruption. It also has a particular relevance given that the Bribery Act 2010 is due to come into force in April of this year.

How can we help you?

We can provide your business with a one hour bespoke training session to explain the implications of the Bribery Act 2010. The wording of the new Act is very wide so it may well affect the way in which your business operates. We can also suggest practical steps to reduce the risk of prosecution.

If you would like more information on the Bribery Act 2010 then please contact Emma Cameron at emma.cameron@mablaw.com

The articles of association of a company (articles) govern its constitution and often contain provisions relating to the transfer of shares. If a company has directors or employees who own shares, the share transfer provisions may contain “good leaver” and “bad leaver” provisions. Such provisions have the effect that, if a director or employee ceases to work for the company, his shares are automatically offered for sale to the other shareholders. If the director or employee leaves for a “good reason”, he receives “fair value” for his shares and if he leaves for a “bad reason”, he receives nominal value for his shares.

The case

A company removed a director (D) and invoked the automatic “good leaver” share transfer provisions in its articles. These provisions stated that D was entitled to the “fair value” of his shares, to be determined by a third party accountant. D nominated three potential accountancy firms and the company selected one of those firms. D then refused to sign the accountancy firm’s letter of engagement, demanding that the company first disclose various documents and taking issue with certain parts of the accountancy firm’s letter of engagement.

The Court of Appeal decided in D’s favour, stating that the agreement to appoint an accountancy firm under the articles had to be a tri-partite agreement between the company, D and the accountancy firm.

The company then brought further proceedings on various grounds, including that:

(a) it was necessary to imply a term into the articles that the accountancy firm’s terms of engagement would be binding on the parties unless otherwise unreasonable;

(b) it was necessary to imply a term into the articles that D was obliged to co-operate with the engagement of an accountancy firm by not unreasonably withholding his consent to an appointment; and

(c) the wording in the articles relating to the appointment of the accountancy firm had broken down and the court should substitute its own wording in order to determine the fair value of D’s shareholding.

Decision

It was decided that:

(1) generally, articles are to be construed in the context of their commercial purpose and in the light of their full text;

(2) the articles in question did not state that the accountancy firm could be appointed on the basis of a unilateral agreement with the company;

(3) having regard to the legal principle that “a contract should better function than perish”, it had to be implied into the articles that D could not unreasonably withhold his consent to the appointment of the accountancy firm. Consequently, D’s actions in withholding consent were unreasonable; and

(4) despite the wording in the articles relating to the appointment of an accountancy firm having broken down, it was not a case that would require the court to step in and take control of the valuation process.

Comment

This case highlights the importance for companies to put in place articles which contain carefully worded share transfer provisions.

Cream Holdings Ltd v Davenport [2010] EWHC 3096 (Ch)

The guidance addresses matters such as: 

1. the constitutional role of shareholders;
2. the collective responsibility of the board and functionality of an advisory board;
3. the size, composition, efficiency, skills and duties of the board of directors;
4. equal treatment of members and effective communication between the board and shareholders;
5. the balance of family governance and corporate governance;
6. the division of responsibilities between board and management;
7. nomination, remuneration and audit committees;
8. appraisals of the board and individual directors; and
9. annual reports to shareholders and other stakeholders.

 The guidance can be viewed via the following link:

http://www.ecoda.org/docs/Corp%20Gov%20Guidance%20and%20Principles%20for%20Unlisted%20Companies%20in%20the%20UK_Final.pdf

• whether there is a problem with short-termism in the UK’s equity markets and if action is needed to encourage investors to take a long term view;
• should the shareholders of a company have a greater degree of control over directors’ remuneration; and
• do boards understand the long-term implications of takeovers and do they communicate such implications effectively?

The LSE is concerned that the FRC will not be able to deal with the real-time monitoring and response required by the UKLA’s functions and this will put London at a disadvantage compared to other markets.

The Bribery Act 2010 (Act) is due to come into force in April 2011. The current English law on bribery was considered to be unsatisfactory because it did not comply with the Organisation for Economic Co-operation and Development’s Bribery Convention, ratified by the UK in 1998. The handling by the English courts of the investigation into bribery allegations against BAE Systems has also been the subject of much criticism. The Act is designed to address these issues.

Commercial organisations will have a defence against the offence of failing to prevent bribery if they can show that they had “adequate procedures” in place to prevent persons “associated” with the organisation from making bribes. The Act does not provide any detail as to what constitutes such “adequate procedures”.

Consultation

The Ministry of Justice has now published a consultation document on guidance for commercial organisations to help them ensure that they have “adequate procedures” in place.

The draft guidance contains 6 principles:

• risk management and mitigation;
• top level commitment to bribery prevention;
• due diligence;
• clear, practical and accessible policies and procedures;
• effective implementation; and
• monitoring and review.

The consultation period is to last 8 weeks, with 8 November 2010 being the deadline for responses. A response will be published early in 2011 together with the final form of the guidance.

The Association of Investment Companies (AIC) has recently published guidance for directors of investment companies to help investment company boards obtain the most appropriate D&O policy. Whilst aimed at investment companies, the guidance highlights principles that directors of other types of company may find useful.

Key points of the guidance worth noting include:

• The board of directors should always remain responsible for arranging their own D&O policies so that they are aware of what is and what is not covered. This is particularly important when subsidiary companies are involved under a group company structure.
• If the board is made responsible for putting in place the D&O cover this will help to ensure that all directors on the board are aware of what losses can and cannot be claimed against.
• Directors should receive advice on the D&O policy before making a claim as inaccurate reporting may lead to insufficient recoveries under the policy.
• Any new directors should be provided with a copy of the D&O policy.
• Consideration should be given as to what effect a merger or acquisition may have on the D&O policy.

If you would like further information on D&O policies, or to see the AIC’s guide in full, please do not hesitate to contact Emma Cameron, or another member of the corporate team at Matthew Arnold & Baldwin LLP.

The terms of the sale of a company’s shares are usually documented in a share purchase agreement (SPA). An SPA will typically list various warranties given by the seller to the buyer. Warranties are effectively promises as to the state of affairs of the company. After completion, if the buyer discovers that a warranty was incorrect as at the date on which it was given, the buyer can use the breach of warranty as the basis for a claim against the seller.

Facts of the case

A recent Court of Appeal decision (Macquarie Internationale Investments Ltd v Glencore UK Ltd) considered whether there had been a breach of a warranty relating to the accounts of the target company. This warranty stated that the accounts:

“give a true and fair view of the assets and liabilities of the Group and/or the Company or the Subsidiary to which they relate as at the Accounts Date and the profits and losses of the Group and/or the Company or the Subsidiary to which they relate (as the case may be) for the Financial Year ended on the Accounts Date (including all related party transactions)”.

After completion, one of the target company’s suppliers produced an invoice relating to services rendered to the company, but which that supplier had mistakenly not produced prior to completion due to an error in loading billing information onto its new computer system.  The invoice came to £3,174,819.91, inclusive of VAT.

The buyer contended that, as a result of the invoice, the seller had breached the accounts warranty, with the effect that the true net asset value of the company was reduced by around 40%.

Decision

At first instance the High Court held that the seller did not have sufficient evidence of its liability to the supplier for the purpose of making a provision in the accounts. The accounts had therefore been prepared in accordance with the relevant accounting standards and there had been no breach of the accounts warranty.

The buyer appealed arguing that whilst it agreed that the accounts had been prepared in accordance with the relevant accounting standards, they did not necessarily give a true and fair view of the company’s assets and liabilities.

The Court of Appeal dismissed the appeal for various reasons including the fact that the seller did not know about, and could not have reasonably discovered, the outstanding invoice at the relevant time. For this reason it could not be said that there was an error in the accounts and it followed that the accounts gave a true and fair view.

Comment

If possible, buyers should request enhanced warranty protection to cover undisclosed liabilities irrespective of whether such liabilities are known to, or reasonably discoverable by, the seller at the relevant time. Whether or not such enhanced protection will be agreed depends upon the relative bargaining strengths of the parties.

The paper follows a report compiled by a committee of the Department for Business Innovation and Skills (BIS Committee) which partly criticised the UK takeover procedures.  However, the government command paper seemingly puts an end to the possibility of any legislative change, stating that it believes that the current legislation is sufficient in allowing intervention in mergers where the interests of the public could be affected.  This is despite admitting that its powers in overseeing Kraft’s delivery of its commitments under the Cadbury takeover would be limited.

The government command paper comes hot on the heels of another consultation paper which was published by the Code Committee of the Takeover Panel. That paper sought comments on possible reforms to the Takeover Code, setting a deadline of 27 July 2010 for the submission of any comments. The government has announced that it will publish a further paper on the regulation of takeovers once it has had a chance to consider the suggestions for reform put forward in response to that paper.

The statutory remedy for a company member who considers that the company’s affairs are being conducted in an unfairly prejudicial manner is contained in section 994 of the Companies Act 2006. This section allows a member to bring an action on the ground that:

• the company’s affairs are being or have been conducted in a manner that is unfairly prejudicial to the interests of the members generally or some part of its members (including at least himself); or
• an actual or proposed act or omission of the company (including an act or omission on its behalf) is or would be so prejudicial.

The meaning of “unfairly prejudicial” conduct has been explored and developed by case law. For example, O’Neill and another v Phillips and others [1999] 2 All ER 961 decided that a member of a company will not normally be entitled to complain of unfairness unless there has been some breach of the terms on which he agreed that the affairs of the company should be conducted. The mere fact that trust and confidence between the parties has broken down is not sufficient.

If a member succeeds in bringing an unfair prejudice action, one of the remedies open to the court is to order the purchase of shares held by certain members of the company by other members.

Case update

A recent case* on unfair prejudice considered the following issues:

• should one party (P) be ordered to buy the shares of the other party (S) or merely agree to do so;
• if an order was made, should the obligation on P to purchase the shares be dependent upon P having the financial means to do so;
• from which date should P be ordered to pay interest to S; and
• on what basis should S’s shares be valued.

The court decided that:

• there ought to be an order for the purchase of S’s shares, as would ordinarily be the case in an action for unfair prejudice;
• there should be no “escape clause” making the order to purchase S’s shares dependent upon P’s ability to pay;
• no interest should be paid; and
• S’s shares should be valued as at the valuation date, not on the date on which S resigned as a director.

Comment

This case is useful as it sets out some of the issues a court will consider when dealing with an unfair prejudice action.

*In the matter of Scitec Group Ltd sub nom Sudhir Sethi v (1) Alpesh Patel (2) Scitec Group Ltd [2010] EWHC 1830 (Ch)

The Hearings Committee concluded that shares had been acquired by a concert party acting on the direction of Mr Myerson in a deliberate attempt to circumvent certain requirements of the Code.  The Hearings Committee also found that key facts had been concealed from the Takeover Panel. 

Mr Myerson  is currently considering an appeal to the European courts.

After an extensive consultation process, the Financial Reporting Council (FRC) has published the new UK Corporate Governance Code (Code).  The Code applies to all companies with a premium listing of equity shares, whether incorporated in the UK or elsewhere. These companies should include a statement in their annual financial reports indicating how they apply the principles of the Code.

Directors’ remuneration

The changes in the Code relating to directors’ remuneration include:

• Non-executive directors were previously prohibited from receiving options in case such options risked their independence. This prohibition now covers “other performance-related elements” of remuneration.
• Companies now have to consider using provisions that allow them to clawback remuneration from directors in exceptional circumstances of misstatement or misconduct.
• The Code now specifically states that remuneration and incentives should be compatible with risk policies and systems.
• The performance-related elements of executive directors’ remuneration should promote the long-term success of the company. 

Directors’ re-election

The issue which was most fiercely debated during the consultation process related to the re-election of directors. The compromise is to introduce annual re-elections for directors but to apply this requirement only to FTSE 350 companies, meaning that smaller premium-listed companies need not hold annual elections. The concern remains that annual re-elections will lead to short-termism which seems at odds with the Code’s emphasis on long-term success.

Conclusion

The amended Code is not ground-breaking but introduces some interesting changes. It may therefore be an appropriate time for remuneration committees to review their remuneration policies and ensure they comply with the Code.

A derivative action is an action brought by a shareholder on behalf of the company. Owing to the complexity of the previous law, very few derivative actions succeeded. When the Companies Act 2006 (2006 Act) came into force, it introduced a wider range of circumstances in which such actions could be brought. A derivative action is now expressly available for a breach of duty by a director, even if the director has not benefited personally from the breach. Furthermore, it is no longer necessary for the shareholder to show that the director(s) who carried out the wrongdoing control the majority of the company’s shares.

Initially, some legal commentators were concerned that activist shareholders would bring such actions simply to disrupt the affairs of the company or make life difficult for its directors.  I initially considered some of the early cases on this new derivative action in January 2010 and concluded that any concerns that activist shareholders would be allowed to use the action frivolously seemed to be unfounded. This was due to the strict application by the courts of the tests set out in the 2006 Act which need to be satisfied before permission to continue a derivative action will be granted.

Since January 2010, permission to continue a derivative claim has been granted in Kiani v Cooper [2010] B.C.C. 463.

Facts of the case

A shareholder (X) sought permission to continue a derivative claim against another director and shareholder (Y) for breach of fiduciary duty.  The court considered various tests as set out in the relevant part of the 2006 Act and decided that, in the circumstances, X was acting in good faith in bringing the derivative action. The court also took the view that a director acting in accordance with his statutory duties to promote the success of the company would decide to pursue the claim, at least to the point of disclosure in the court proceedings.  The court therefore held that X had made out a case for breach of fiduciary duty by Y to the relevant standard and allowed the derivative claim to be continued to the point of disclosure.

Comment

This case demonstrates that it is possible for a shareholder to succeed in a claim for permission to continue a derivative action. However, the fact that the court only granted permission to the point of disclosure indicates that the courts will still apply a strict interpretation to the tests set out in the 2006 Act.

Background

The Partnership Act 1890 defines a partnership as the relationship which exists between persons carrying on a business in common with a view to profit.  It is a matter of fact whether a partnership exists and the parties cannot simply determine this for themselves.  Usually the relationship is governed by a partnership agreement and we would advise that a partnership agreement is always put in place so as to set out the rights and obligations of each of the partners.  However, the essence of a partnership is the continuing relationship between the partners, personal as well as commercial, with the partnership agreement being only an indication of the relationship.

When the courts have to consider whether a partnership exists, they look at the substance of the arrangements and not the stated intentions of the parties.  The partnership has to be carried “with a view to profit” but this does not require that profit should actually be made.

The case

The father claimed that a courier business had been run as a partnership between him and his son, with the son carrying out the work and the father providing business advice based on his years of commercial experience.

The court found that none of the documents submitted in evidence showed that the father had an interest in the business beyond the fact that he had helped his son to set up the business.  Such assistance was not sufficient to create a partnership between the father and the son.

Comment

This case highlights the importance for parties to consider the nature of their business relationship and, if the aim is to work in partnership, put a partnership agreement in place.

Roger Marsh v (1) Simon Cameron Marsh (2) Time Critical Ltd [2010] EWHC 1563 (Ch)

Background

A court has ruled as a preliminary issue that where a partnership deed is silent as to the basis of valuation for the purpose of determining the amounts payable to outgoing partners, such amounts have to reflect a fair value of the partnership’s assets and cannot be based on historical annual accounts which greatly underestimate the value of the partnership’s main asset which, in this case, was land.

Facts

The partnership deed provided that when a partner retired, died, became bankrupt or became a patient under the mental health legislation, his share in the assets of the partnership would accrue to the surviving partners in the same proportions as their respective shares in the partnership property, and the outgoing partner (or his personal representative) would be paid the amounts standing to his credit as his share in the capital of the partnership and as undrawn profits belonging to him in the “last annual general account prior to his retirement, death or bankruptcy or becoming a patient”.  However, no accounts had been agreed for any of the relevant years.

Decision

The court held that the outgoing partners were entitled to a “fair value” which was the market value of the land in question unless there was an agreement to the contrary, or there were other factors rendering such a value unfair. 

Comment

In the circumstances, the court decided in favour of the outgoing partners receiving a “fair value” but the case is nonetheless an important reminder that it is best to include clear valuation provisions in any partnership deed and ensure that proper and up-to-date accounts are kept so as to avoid the extra expense and stress of a court application at the time of determining an outgoing partner’s share.

Drake v Harvey & Ors [2010] EWHC 1446 (Ch) ]]> http://www.mablaw.com/2010/06/valuation-of-partnership-assets/feed/ 0 http://www.mablaw.com/2010/06/takeover-panel-publishes-consultation-paper/ http://www.mablaw.com/2010/06/takeover-panel-publishes-consultation-paper/#comments Fri, 04 Jun 2010 16:23:30 +0000 Emma Cameron http://www.mablaw.com/?p=3751 Following on from recent criticism of the takeover of Cadbury Plc by Kraft Foods, the Code Committee of the Takeover Panel (Committee) has published a consultation paper to discuss shortcomings in the current takeover process.  Whilst not stating actual recommendations for change, the Committee does propose potential amendments to the Takeover Code (Code) and highlights some of the key areas to be considered.  These areas include:

• Acceptance condition thresholds

The Committee considers that changing the threshold at which conditions can be accepted could better reflect the views of longer term shareholders which, in turn, should (theoretically) better reflect the best interests of the company. However, the Committee also notes several issues to be considered if such changes are made, including the imposition of buying restrictions during the offer period.

• The “disenfranchisement” of shares acquired during an offer period

The Committee suggests discounting votes made by those shareholders whose shares are acquired during the offer period. This could again be seen to reflect the interests of longer term shareholders, as well as reducing share trading during the offer period and thereby stabilising the share price.  The Committee also recognises the numerous potential difficulties with this proposal. For example, if an offer turns out to be unsuccessful, at which point should voting rights be reinstated?

• Disclosures in relation to shares and other securities

One of the Code’s aims is to provide as much transparency in the takeover process as possible.  To this end the Committee suggests reducing the threshold at which large shareholders must disclose their interests to small shareholders with less than a 1% shareholding, as well as introducing an obligation to disclose acceptances and voting decisions. However, the Committee notes that the 1% threshold is already well below requirements contained within other codes of practice, and that a substantial increase in disclosure may result in ‘over-disclosure’ which could ultimately cause confusion.

• Advice, advisers and advisory fees

In keeping with the principle of transparency, the Committee proposes that the Code should require public disclosure of advisers’ fees and costs although opponents argue that sensitive information may be disclosed as a result. 

• The “put up or shut up” regime, “virtual bids” and the offer timetable.

The concept of ‘Put up or Shut Up’ relates to an offeree company’s ability to request the Takeover Panel to impose an offer deadline on an offeror company.  It has been suggested that such a deadline be reduced to a standard period. Critics believe that this may not be in the interests of the offeree’s shareholders as the offeree’s board may not have sufficient time to fully consider an offer.

• Substantial acquisitions of shares

Following the abolition of the rules against speedy acquisitions of a company’s shares, there are arguments to reintroduce time limits under which a specified proportion of shares can be acquired. However, in response to this the Committee states that ‘market raids’ are relatively rare and it is not the role of the Takeover Panel to decide who can acquire shares.

The Committee has requested comments on the consultation by 27 July 2010 after which it will decide whether any reform of the Code is required.

The issue in question surrounded Cadbury Plc’s facility at Somerdale which, in 2007, Cadbury had announced would be the subject of a phased closure scheme during 2009 and 2010.  In several offer documents, Kraft stated its belief that the facility could remain open.

These statements fell foul of the two part test contained within rule 19.1 of the Takeover Code.  This rule relates to the bidder and target upholding standards of care during the takeover process, particularly in conjunction with rule 24 of the Takeover Code, which governs the information required in the bidder’s offer documents.  In this instance, the Takeover Panel found that when declaring that the facility could remain open, Kraft should not only have honestly and genuinely believed this to be true, but should also have had a reasonable basis for making such a declaration.  Kraft failed on the second part of the test.

Kraft’s leading financial advisers, Lazard & Co, can count themselves lucky to escape the public criticism levelled at Kraft.  Whilst the Takeover Panel deemed them to be partly responsible for failing to provide the information on which Kraft needed to rely when making the relevant statements, it did not consider it necessary to publicly criticise Lazard in the same manner as Kraft.

This decision by the Takeover Panel is a helpful reminder that financial advisers, as well as bidders, must at all times carefully follow the rules of the Takeover Code and should be alert to the repercussions of failing to do so.

“Tail-gunner” clauses are often used by corporate finance advisers in their terms of engagement so that if a transaction completes within a certain period after the termination of their engagement, a success fee is payable to the adviser despite the fact that they are no longer engaged at the date of completion.  The clause is so-called as it refers to the parting shot of a bomber finishing his sortie.  A recent case has upheld the use of such a clause.

Facts of the case

Grandtop International Holdings Limited (Grandtop) engaged Seymour Pierce Limited (Seymour Pierce) in June 2007 to advise on its acquisition of Birmingham City Football Club (club). It was initially envisaged that the transaction would proceed by way of a recommended takeover. The terms of engagement provided for a £2.2 million success fee and stated:

“In the event the engagement pursuant to this letter of engagement is terminated by the Company and an Offer for the Target is declared or becomes wholly unconditional as the result of any offer made by or in association with the Company within a period of 12 months after the effective date of termination the Company shall pay to Seymour Pierce the Success Fee in full.”

The transaction did not proceed in the manner which had been envisaged and Seymour Pierce’s involvement declined, resulting in their engagement being formally terminated in May 2009. Grandtop eventually completed (with input from another corporate finance adviser) its acquisition of the club in September 2009, 4 months into the “tail-gunner” period. Seymour Pierce sued for the success fee.

Decision

Grandtop argued that Seymour Pierce had not been the effective cause, or even one of the effective causes, of the final transaction and did not deserve the success fee. However, the court held that the terms of engagement clearly stated that the success fee was payable irrespective of whether Seymour Pierce had been responsible for completion of the transaction in its final form.

Comment

The case turned on the wording used in Seymour Pierce’s terms of engagement and therefore highlights the importance of careful drafting. In hindsight, Seymour Pierce’s terms seemed uncommercial and unreasonable as they resulted in Grandtop having to pay the fees of two sets of corporate finance advisers. Nonetheless, the court found in favour of Seymour Pierce. This is good news for corporate finance advisers but not for their clients who should, despite such a clause often being non-negotiable, try at least to limit its duration.

Seymour Pierce Limited v Grandtop International Holdings Limited [2010] EWHC 676 (QB)

A “de facto director” is a person who acts as if he is a director of a company and is treated as such by the company’s board but has not in fact been validly appointed. A de facto director is subject to the usual directors’ duties and can be the subject of actions against directors such as a “misfeasance” action under section 212 of the Insolvency Act 1986 (IA 1986) requiring the de facto director to repay, restore or account for any money or other property of the company which he has misapplied or retained or to contribute a sum to the company’s assets by way of compensation. 

Facts of the case

Person X was a human director of Company Y. Company Y was the corporate director of Company Z. Company Z allegedly underpaid tax to an extent which resulted in the unlawful distribution of dividends to its shareholders.

HMRC issued proceedings under section 212 of IA 1986 against Person X, claiming that because he was a human director of Company Y, he could also be regarded as a de facto director of Company Z and had therefore breached his directors’ duties and was guilty of misfeasance in respect of Company Z.

Decision

The Court of Appeal held that Person X was not a de facto director of Company Z as he had not done anything more than to act as a human director of Company Y. That was not, of itself, sufficient to make him a de facto director of Company Z. There was no evidence that Person X had himself acted as a director of Company Z.

The Court of Appeal stated that there is no basis in law or principle to hold that a human director, who causes a corporate director to exercise active control over a subject company, automatically becomes a de facto director of the subject company.

Comment

The case gives useful guidance on the circumstances in which a person will be found to be, or not to be, a de facto director. Such a finding can have important consequences, particularly as regards an insolvent company.

The case also reiterates the importance of a company properly appointing its directors so that there can be no doubt as to who is on its board.

Holland v HM Revenue & Customs; Re Paycheck Services 3 Ltd [2010] B.C.C. 104

• the size and composition of the board should reflect the scale and complexity of the company’s activities;
• the board should meet regularly to discharge its duties, and be supplied in a timely fashion with appropriate documentation;
• all directors should receive induction on joining the board and should regularly update and refresh their skills and knowledge; and
• family-controlled companies should establish family governance mechanisms that promote coordination and mutual understanding amongst family members, as well as organise the relationship between family governance and corporate governance.

Adherence to the principles is entirely voluntary but ecoDa hopes that the principles will provide a foundation upon which individual member states can develop country-specific principles. As regards UK companies, any such voluntary principles would be in addition to the usual statutory duties which already automatically apply to all directors and are now contained in the new Companies Act 2006.

Facts

Mr Calvert was a partner and trader at the stockbroking firm Cazenove.  He passed inside information relating to shares in six different companies to Mr Hatcher who proceeded to invest in those companies, resulting in a net profit of over £100,000. Mr Calvert and Mr Hatcher then split the profit between them.

The FSA entered into an agreement with Mr Hatcher whereby in exchange for his cooperation with the FSA, including standing as a key witness, the FSA agreed to sanction Mr Hatcher using its regulatory powers rather than via a criminal prosecution. Mr Hatcher’s fine was also substantially reduced but nonetheless still amounted to £56,098.

Comment 

The convictions are interesting as the FSA’s director of enforcement and financial crime specifically stated that the FSA will continue to enter into similar agreements with defendants where it believes that such agreements will result in valuable evidence for convictions being produced.

The convictions are also examples of the continued efforts by the FSA to crack-down on illegal activity in the financial markets, perhaps increased by the wide media criticism of the perceived failure by the FSA to control such markets in the past.  It will be interesting to see if any reallocation of the roles of the FSA and the Bank of England following the general election this summer has any further effect on the prosecution of such crimes.

Peter Mandelson (the Business Secretary) has since proposed various reforms to takeover laws including:

• raising the voting threshold required to approve a hostile bid
• denying short-term shareholders such as hedge funds the right to vote during a bid period
• giving bidders less time to formally commit to their offer (“put up or shut up”) so as to reduce the length of time a takeover bid takes to complete
• requiring bidders to set out publicly how they intend to finance their bids over the long term and how they intend to make cost savings

The proposals have, however, received a mixed response. Some commentators are in favour of protecting companies from hostile bids but others would prefer takeover laws to remain the same so as to allow a company’s shareholders (rather than its board of directors) to determine the outcome of a takeover bid.

A recent Court of Appeal decision has the effect that in some circumstances a company which a holding company considers to be its subsidiary may not in fact be its subsidiary.

Statutory background

Section 736 of the Companies Act 1985 (1985 Act) states that a company is a “subsidiary” of another company (its “holding company”) if that other company:

• holds a majority of the voting rights in it
• is a member of it and has the right to appoint or remove a majority of its board of directors
• is a member of it and controls, alone, pursuant to an agreement with other members, a majority of the voting rights in it,

or if it is a subsidiary of a company which is itself a subsidiary of that other company.

A key clause in the relevant documentation considered in the case defined a company as being an “affiliate” of another company if both companies are subsidiaries of the same holding company. The clause referred to the definition of “subsidiary” in the 1985 Act. The substance of the relevant provisions of the 1985 Act is reproduced in the new Companies Act 2006 (2006 Act) so the decision applies equally to the definition of “subsidiary” in the 2006 Act.

Factual background

Enviroco Ltd (Enviroco) was an affiliate of Asco UK Ltd (Asco UK) by virtue of having the same holding company (Asco plc). Farstad Supply A/S (Farstad) chartered a ship to Asco UK. Enviroco was engaged to carry out maintenance work on the ship.

Asco plc “pledged” its shares in Enviroco to a bank by a Scottish law “deed of pledge”. Pursuant to this pledge, Asco plc’s shares in Enviroco were registered in the name of the bank’s nominee. The deed of pledge made it clear that the registration of the bank’s nominee as the holder of the shares was for the purpose of security only, and the voting rights remained with Asco plc.

A fire then occurred, causing damage and the death of an Enviroco employee. Farstad brought proceedings against Enviroco, who tried to protect itself against the claim by using an indemnity clause in the charter-party agreement. The indemnity clause only applied to Asco UK’s “affiliates” so the High Court had to decide as a preliminary issue whether, as a result of the share pledge and the registration of the bank’s nominee as the holder of the Enviroco shares, Asco plc had ceased to be a holding company of Enviroco (and therefore whether or not Asco UK and Enviroco had ceased to be affiliates of one another).

High Court decision

The High Court held that “as a matter of commercial common sense” the registration of the shares in the name of the bank’s nominee was only for the purpose of giving effect to the bank’s security. Asco plc had therefore retained control of Enviroco, meaning that Enviroco was a subsidiary of Asco Plc (and an affiliate of Asco UK) and could benefit from the indemnity.

Court of Appeal decision

Farstad appealed to the Court of Appeal, which overturned the decision of the High Court. Its rationale was that, although it did not necessarily make sense to decide that Enviroco had ceased to be a subsidiary of Asco plc, the Court was limited in the extent to which it could correct errors in the 1985 Act (or any other Act of Parliament).  In the circumstances of this case, section 736 of the 1985 Act had to be interpreted to mean that Enviroco had ceased to be a subsidiary of Asco plc (and an affiliate of Asco UK) and therefore Enviroco could not benefit from the indemnity.

Comment

Until such time as the law is clarified by the Supreme Court when it hears Enviroco’s appeal against the Court of Appeal decision, English companies should be wary of granting legal mortgages over shares and instead grant security over shares by way of equitable charge (as tends to be the usual practice anyway).

The definitions of “subsidiary” and “affiliate” in contracts and finance documents commonly cross-refer to the definitions in the 1985 Act (or the restated definitions in the 2006 Act). Group companies should therefore check their contracts and finance documents and, if the statutory definitions are referred to, seek advice as to whether or not the case impacts on their activities.

Enviroco Ltd v Farstad Supply A/S [2009] EWCA Civ 1399

The Corporate Manslaughter and Corporate Homicide Act came into force in April 2008. It created a new offence of corporate manslaughter, committed by organisations rather than by individuals. The Sentencing Guidelines Council has now published definitive guidelines on the sentences which an organisation convicted of corporate manslaughter (or a health and safety offence causing death) can receive.

Sentencing guidelines

The guidelines list the following type of sentence:

• Fine
• Remedial order
• Publicity order

Fine

The guidelines confirm that the appropriate fine for a conviction of corporate manslaughter “will seldom be less than £500,000 and may be measured in millions of pounds”. Where a health and safety offence has caused death “the appropriate fine will seldom be less than £100,000 and may be measured in hundreds of thousands of pounds or more”.  The guidelines expressly state that in a “bad case”, it may be appropriate for an organisation to be put out of business.  However, the guidelines do acknowledge that imposing high levels of fine on the public and not-for-profit sectors may have an adverse effect on the services provided by such sectors.

Remedial order

A remedial order will require an organisation to address specific failings which were involved in the offence. The court will not take into account the cost of complying with a remedial order when setting any fine which also forms part of the sentence.

Publicity order

The object of a publicity order is “deterrence and punishment”. Such an order may require details of the conviction, such as the amount of the fine and the terms of any remedial order, to be made public.

Comment

The guidelines confirm that there may be hugely detrimental implications (both financial and reputational) for organisations that are found guilty of corporate manslaughter.

The Companies Act 2006 (2006 Act) came fully into force on 1 October 2009. The Act aimed to simplify company law procedures, particularly for smaller companies. The 2006 Act does not require companies to amend their articles of association (Articles) but in order to take advantage of the simplified procedures, any company which was incorporated before 1 October 2009 (Existing Company) may wish to do so. For the purpose of this note we have focused on private limited companies, as it is this type of company which can benefit the most from the new deregulatory regime.

What amendments can be made?

Company secretary

• As from 1 October 2008, the requirement for private limited companies to have a company secretary has been abolished. In the past many smaller companies which were effectively a “one-man” business struggled to find someone to act as the company secretary and typically a wife or accountant would take up the role.  Such persons may now wish to resign as company secretary. However, an Existing Company should ensure that its Articles are amended so as to remove any references to a requirement for it to have a company secretary. Please note that the directors need to ensure that someone still performs the tasks previously performed by the company secretary (such as filing forms at Companies House).

 Objects

• Under the former Companies Acts, a company had to act within a specific list of powers (or “objects”) set out in its memorandum of association (Memorandum). These objects could limit, for example, a company’s ability to borrow money or grant security. Under the 2006 Act the objects are deemed to form part of a company’s articles but, as part of the adoption of new Articles, they can be removed. The benefit of doing this is that the company has unlimited objects and, for example, can enter into loan or security documents without the need for the directors or bank to scrutinise the Memorandum or Articles.

 Authorised share capital

• Before 1 October 2009, all companies had an “authorised share capital” which was effectively a limit on the total number of shares which could be issued without seeking further approval from the shareholders. Under the 2006 Act, companies do not need to have an authorised share capital but any references to this concept in an Existing Company’s Articles or Memorandum will need to be removed if the company is to benefit from this deregulatory measure.

 Allotment of shares

• The directors of private limited companies with only one class of shares can now allot shares of the same class without obtaining shareholder approval, subject to any restrictions in the Articles. Directors of an Existing Company should therefore check the Articles to ensure that there are no such restrictions.

Change of name

• Previously, a company could only change its name if the holders of 75% per cent or more of its issued shares passed a change of name resolution. Under the 2006 Act, a company is still able to change its name in this way but it can also set out in its Articles other methods for changing its name, for example, by way of a board meeting (thereby avoiding the need for shareholder approval).

What about companies incorporated after 1 October 2009?

Companies which are incorporated after 1 October 2009 should adopt articles of association upon incorporation which allow them to take full advantage of whichever aspects of the deregulatory regime are relevant.  For some companies this will simply mean using the new “Model Articles” which apply by default under the 2006 Act in the absence of the adoption of specific Articles.

Summary

Existing Companies should consider amending their Articles so as to streamline certain decision making and administrational procedures.  The extent to which such amendments are appropriate will vary from company to company and specific advice should be sought in each case.

It is probably quicker (and cheaper) for an Existing Company to make any amendments by adopting an entirely new set of Articles rather than making the changes piecemeal as and when a specific issue arises.

It is no secret that the M&A market has been in the doldrums of late, with acquisition plans being shelved whilst companies establish some stability in their own businesses. However, the recent activity would seem to signal increasing confidence amongst executives which may indicate a thaw in the market. There is still some uncertainty and in such times buyers, looking for a bargain, will be cautious about overpaying whilst sellers, looking for reasonable prices, will be wary of short-changing themselves. Reports in the media are that the recession is easing (or ended) and that things are stabilising. Potential buyers may be concerned that targets will become more expensive if they delay and if M&A really sparks again, this means there will be a premium placed on stocks.

What is clear from the examples above is that we are not presently seeing the return of the private equity firms that fuelled much of the merger mania prior to the credit crunch. The large deals announced recently are strategic, in that they involve one company buying another to make it an integral part of its business. In contrast, many of the pre-credit crunch takeovers involved the buyer taking on mountains of new borrowing to pay for the acquisition which left many companies struggling to make interest payments. The lack of access to loans following the seizure of the credit markets makes the early return of these transactions difficult to envisage.

So what about the BA/Iberia merger? The recession has eroded travel demand and punished airlines to the extent that the global airline industry is set to post total losses for 2009 exceeding $11 billion.  Mergers present the only option available to airlines to execute signifcant rationalisation to combat over capacity and governments (who have strict control or influence over airlines) are realising that, in the long term, access to foreign capital and a more rational use of airline assets through international alliances and mergers, is the way forward.

At present, for some sectors at least, confidence is returning and that big-ticket strategic (but not private equity-backed) mergers and acquisitions are back on the agenda. In other sectors (most notably the airline industry) the final repercussions of the recent disruptions in the world economy have yet to be felt and in those sectors we might see some more mergers of necessity to effect rationalisation. In both cases, increased M&A activity seems inevitable.

The claimant (Invertec) and the first defendant (De Mol Holding BV (DMH)) entered into a sale and purchase agreement for the sale by DMH to Invertec of all of the issued shares in Volante Public Transportation Interior Systems Limited (Volante).

After the sale, Invertec had to inject cash into Volante to pay outstanding debts (including debts owed to suppliers and HM Revenue & Customs). Invertec claimed that it had been induced to purchase Volante by a number of representations made by DMH and its director as regards Volante’s solvency, management accounts, corporation tax liabilities and a customer contract. These representations had been given both during the course of negotiations and as warranties in the sale and purchase agreement. Invertec alleged that DMH had given the representations fraudulently and breached the warranties in the agreement.

As is normal in private company sales, DMH had provided Invertec with a disclosure letter setting out details of matters which were inconsistent with the terms of the warranties so as to protect DMH from being sued by Invertec as regards any such disclosed matters.

Decision

The High Court found that DMH had given the representations fraudulently and breached the warranties in the sale and purchase agreement.  However, Invertec did not succeed with its claim that a fraudulent misrepresentation was made as regards the customer contract because DMH had disclosed that the contract was loss-making in the disclosure letter.

The High Court also found that the fraudulent misrepresentations had largely been made by DMH’s director on behalf of DMH. The director was therefore personally liable for the fraudulent misrepresentations.

Comment

The case is a reminder of the importance of a seller making detailed and accurate disclosures in its disclosure letter.

It also shows that if a claimant purchaser can discharge the burden of proving that a defendant had no honest belief in representations it made, any director who made such representations can be found personally liable.

Invertec Ltd v De Mol Holding BV & Anor [2009] EWHC 2471 (Ch)

The Association of British Insurers (ABI) is the trade association for the UK’s insurance industry.  The ABI has around 400 companies in its membership.  ABI member companies account for almost 15 per cent of investments in the UK stock market.  The ABI therefore acts as a voice for many of the UK stock market’s largest investors.

The ABI’s role in corporate governance

The ABI provides information and guidance on corporate governance issues to investors and listed companies in which those investors invest.  As part of its drive to promote best practice in corporate governance, the ABI’s publications include guidelines on executive remuneration.  The recent position paper does not replace the current guidelines but aims to highlight those elements of the guidelines that are of particular relevance at the moment given today’s economic climate.

The new position paper

Comments made by the ABI in the position paper include:

• Concerns over the retention of directors are not sufficient grounds on their own to justify increases to directors’ remuneration, nor is a company’s increased market capitalisation
• If a remuneration committee contemplates using a “material use of discretion”, the company’s shareholders should be consulted on this decision
• Companies should not incur additional costs in the implementation of tax efficient remuneration structures. This is of particular note given the increase in income tax for the UK’s highest earners with effect from 6 April 2010
• If a company experiences an exceptional negative event, bonus payments to its directors should be discouraged. Any bonus payments which are made in such circumstances need to be carefully justified
• Any awards which depend upon performance should be justified by the company’s underlying performance and not only by its performance relative to a comparator group

 Comment

The position paper will be of interest not only to listed companies but to all companies who wish to take steps to address concerns which may have been raised by their shareholders about the remuneration paid to directors.

Background

On 3 occasions in the summer of 2004 Mr Patel placed a series of spread bets on listed companies. The FSA claimed that Mr Patel was only able to place such bets on the basis of restricted information provided to him by Mr Chhabra, as the relevant information was not generally available to the public.

At the time the bets were placed, Mr Chhabra was a research analyst at Evolution Securities Limited, covering Ebookers plc and Eidos plc. Mr Patel was his friend and an experienced spread better. Mr Chhabra became aware of restricted information relating to Ebookers plc and Eidos plc and he passed it on to Mr Patel. Mr Patel placed bets on these companies shortly after receiving such information. Mr Patel profited to the sum of £85,541 from the bets.

FSA decision

In November 2008 the FSA issued a Decision Notice on Mr Chhabra and Mr Patel notifying them that the FSA had decided to impose penalties on them for market abuse. The FSA also prohibited them from performing functions in relation to any regulated activities. Both Mr Patel and Mr Chhabra denied that they had engaged in market abuse and referred the Decision Notice to the FSMT.

FSMT decision

Mr Chhabra admitted to the FSMT that, with hindsight, it could appear suspicious to communicate with a third party while in possession of restricted information but argued that this was not evidence of wrong-doing. However, after having considered the evidence as a whole, the FSMT upheld the FSA’s findings that Mr Patel’s bets had been placed on the basis of the restricted information passed to him by Mr Chhabra. Both Mr Chhabra and Mr Patel had therefore engaged in market abuse. A separate FSMT hearing will consider whether the penalties and prohibition imposed by the FSA are appropriate.

Comment

In its decision the FSMT explicitly stated that it regards allegations of market abuse as serious allegations. This decision shows that market abuse will not be tolerated by the FSA or the FSMT and should serve as a warning to anyone in a similar position to Mr Chhabra or Mr Patel who is tempted to engage in abusive practices.

Robin Chhabra and Sameer Patel and FSA

A derivative action is an action brought by a shareholder on behalf of the company. Owing to the complexity of the previous law, very few derivative actions succeeded. When the Companies Act 2006 (“the 2006 Act”) came into force, it introduced a wider range of circumstances in which such actions could be brought. A derivative action is now expressly available for a breach of duty by a director, even if the director has not benefited personally from the breach. Furthermore, it is no longer necessary for the shareholder to show that the director(s) who carried out the wrongdoing control the majority of the company’s shares. 

Initially, some legal commentators were concerned that activist shareholders would bring such actions simply to disrupt the affairs of the company or make life difficult for its directors. This was despite the 2006 Act containing some procedural hurdles which must be overcome before a shareholder can bring a claim for a derivative action. Recently there have been some cases which consider such hurdles.

Recent cases

In Franbar Holdings Ltd v Patel and ors [2008] EWHC 1534 (Ch) the judge refused an application for permission to continue a derivative action partly on the basis of one hurdle, which requires the court to be satisfied that a director acting in accordance with his duty to promote the success of the company would seek to continue the claim. The judge identified several factors which the hypothetical director would take into account which included: the prospects of success of the claim; any damage to the company’s reputation and business in the event of the action failing; and the cost of the proceedings. The judge considered that in the circumstances it was not possible to conclude that such a director would continue the claim. The failure to overcome just one hurdle was sufficient for the judge to refuse permission. Another key reason for the refusal was the ability for the shareholder to seek a different remedy under the 2006 Act on the basis of what is known as “unfair prejudice”.

In Stimpson & Ors v Southern Landlords Association [2009] EWHC 2072 (Ch) permission to continue a derivative action was again refused. The judge gave a long list of reasons to support his view that a hypothetical director would not seek to continue the action. The judge also stated that if even he was wrong on that specific point, his refusal could be justified on other grounds.

In Iesini v Westrip Holdings Ltd [2009] EWHC 2526 (Ch) the judge emphasised the importance for the derivative action to be based on an act or omission involving negligence, default or breach of duty by a director. As the directors had followed the advice of eminent professionals, the judge considered that they had not been negligent or breached their duties.

Summary

It appears that the courts will interpret the 2006 Act strictly when determining whether the new derivative action can be used. Therefore, for the moment at least, any concerns that activist shareholders will be allowed to use the action frivolously seem to be unfounded.

Directors of companies have always been subject to various duties but until the Companies Act 2006 (“the 2006 Act”) came into force, these duties had not been consolidated and set out in one place.  The duties set out in the 2006 Act are the: 

1. Duty to act within powers (which means that a director must act in accordance with the company’s constitution and  must only exercise his powers for their proper purpose)

2. Duty to promote the success of the company (which means that a director must act in the way he considers, in good faith, would be most likely to promote the success of the company for the benefit of its members as whole)

3. Duty to exercise independent judgement

4. Duty to exercise reasonable care, skill and diligence

5. Duty to avoid conflicts of interest

6. Duty not to accept benefits from third parties

7. Duty to declare interests in proposed transactions or arrangements with the company  

Although the 2006 Act sets out or “codifies” directors’ duties, the 2006 Act provides that the new duties are to be interpreted and applied in the same way as the previous case law and therefore such case law still needs to be followed. It should also be noted that the codification is not exhaustive and does not cover all of the duties which a director may owe to a company, such as: the duty to consider or act in the interests of creditors and the duty of confidentiality owed by a director to the company. The new duties are cumulative so where more than one duty applies in a given case, the directors must comply with each applicable duty.

Consequences of breach

The consequences of a breach of the new duties are the same as for breach of the corresponding common law or fiduciary duties.

 Ratification

The 2006 Act has significantly amended the law on ratification so that any decision by a company to ratify conduct by a director which amounts to negligence, default, breach of duty or breach of trust must be taken by the shareholders without reliance on the votes in favour by the director or any person connected to him (e.g. certain family members).

Actions requiring the approval of the company’s shareholders

There are certain types of transaction between a company and its directors which must be approved by the company’s shareholders. These transactions include loans to directors and service contracts which are more than two years in duration. However, perhaps the transactions of most relevance which require shareholder approval (or should only be entered into subject to shareholder approval) are “substantial property” transactions which are defined as arrangements between the company and a director (or a person connected with a director) of the company itself or its holding company relating to non-cash assets which either: (a) exceed 10% of the company’s asset value and are worth more than £5,000; or (b) exceed £100,000.

Summary

Despite directors’ duties being codified in the 2006 Act, the former law is still relevant when interpreting such duties. Directors should therefore seek advice if they are concerned about breaching any duties so as to ensure that they understand the full extent of such duties. Directors must take particular care when entering into transactions with companies of which they are directors and, dependent upon the nature of the transaction and the company’s articles of association, declare their interest to the other directors and/or seek the approval of the shareholders as regards such transactions.

One way of protecting your business in the event of a shareholding director’s death or critical illness is for the shareholders to enter into cross option agreements supported by life insurance policies.

A cross option agreement gives surviving shareholders the right (but not the obligation) to require the deceased shareholder’s personal representatives to sell the shares to them (known as a “Call Option”). It also gives the personal representatives the right (but not the obligation) to require the surviving shareholders to buy the deceased shareholder’s shares (know as a “Put Option”). By combining a Call Option with a Put Option in a single agreement each side has the option of ‘forcing’ a sale of the shares.

Cross option agreements should also oblige each party to insure their lives under a life insurance policy for a value which reflects the value of their shares. The proceeds of the policy should be held on a trust for the other shareholders who will be the beneficiaries. These proceeds provide the remaining shareholders with the cash to buy the shares of the deceased shareholder.

The cross option agreement should provide a mechanism for determining the price payable for the shares on the exercise of the option. By providing the price and terms of payment in advance a significant area of dispute is minimised.

The structure of the cross option is vitally important for taxation planning purposes.  Important tax reliefs for both inheritance tax and capital gains tax can be lost if the documentation is not properly structured.

The arrangements described above create an instant market for the shares left by a deceased shareholding director and the linked life insurance policies held on trust for the remaining shareholders provide the funds to complete the purchase. The business of the company is left in the hands of those who are committed to the long-term success of the company whilst loved ones receive the value of the shares in cash assisting them to rebuild and move on with their lives.

The shareholders agreement gave certain shareholders the right to force one particular shareholder to buy their interest out at the greater of two valuation methods and the ambiguity concerned whether a price reduction mechanism applied to both valuation methods. On the face of the agreement the price reduction method only applied to one of the valuation methods. The price for the departing shareholders’ shares would be £2,673,940 instead of £5,142,195 if the price reduction mechanism applied.

The issues for the Court to consider were whether there was an error or absurdity produced by the ordinary meaning of the language used in the clause and, secondly, if there was, whether it was clear that reasonable people in the position of the parties at the time would have objectively intended, in effect, that the price reduction mechanism applied to both valuation methods.

There was no doubt about the natural meaning of the words chosen and no room for inferring an obvious mistake. There was no obviously wrong date or number. One valuation might appear favourable to the selling shareholders but it did not make the structure arbitrary and irrational, nor were there any obvious defects of omission. Whilst the particular provision appeared generous, the Court could not evaluate the commercial good sense or the economic consequences of the clause in the wider context of the overall merger.

This case reaffirms the position that Courts are unwilling to amend the wording of commercial agreements where there is a complex merger in which both parties are legally advised. Great care must be taken when preparing complicated and detailed provisions in shareholder and joint venture agreements.

Bishops Wholesale Newsagency Limited and others v Surridge Dawson Limited [2009] EWHC 2578 (Ch)