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.

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.

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)