Corporate Law Update: 22 - 28 May 2021

28 May 2021

In this week’s CLU: Wilful misconduct leaves a seller exposed to breaches of warranty with no contractual limitations, the FRC launches the first stage of its scenario analysis study and publishes research on FTSE 350 workforce engagement, a company director did not breach their duty to avoid a conflict by negotiating an additional bonus for an employee, the UK Endorsement Board now has responsibility for implementing UK-endorsed IAS and the FRC is seeking views on how ready companies are to begin reporting in XHTML.

Covid-19 is affecting the way people conduct their business, retain their staff, engage with clients, comply with regulations and the list goes on. Read our thoughts on these issues and many others on our dedicated Covid-19 page.

Sellers’ wilful misconduct excluded contractual limitations on liability

The High Court has examined whether wilful misconduct by the sellers of shares excluded any contractual limitations on their liability in connection with the sale.

What happened?

MDW Holdings Ltd v Norvill [2021] EWHC 1135 (Ch) concerned the sale of a waste management company whose business included the processing and disposal of dry and wet waste. For a detailed summary of the background to the case, see our previous Corporate Law Update.

Last week we looked at whether false due diligence responses made by the sellers amounted to fraudulent misrepresentations. This week we look at whether the sellers also committed breaches of contractual warranties relating to the company.

The buyer and the sellers had entered into an agreement for the sale of the shares in the company (the SPA). As is typical, the SPA contained various warranties relating to the state of the company and its business. These included environmental warranties and warranties stating that the company had complied with all applicable laws.

The SPA also contained several contractual limitations on the sellers’ liability for breach of warranty. These included a fairly standard provision excluding any liability for breach of warranty unless the buyer gave the sellers written notice "summarising the nature of the Claim (in so far as it is known to the Buyer) and, as far as is reasonably practicable, the amount claimed" within two years of completion of the sale.

Finally, the SPA stated that none of these limitations affected the sellers’ liability arising out of any dishonesty, fraud, wilful misconduct or wilful concealment by the sellers or their agents or advisers. Again, this is standard.

The court found that, during the buyer’s due diligence exercise, the sellers had withheld information, or provided inaccurate or falsified information, when responding to the buyer’s enquiries. It found that, by doing so, they had committed fraudulent misrepresentations and were liable to compensate the buyer.

As well as amounting to misrepresentations, the buyer claimed that this failure to provide accurate information also amounted to breaches of the warranties in the SPA. In particular, it claimed that, by failing to comply with and commit expenditure to the company’s environmental obligations, its profits had been artificially inflated and the buyer had paid more for the company than it was worth.

The buyer sent the sellers written notice of its intention to claim for breach of the warranties and, subsequently, brought legal proceedings for breach of contract.

The sellers, in response, relied on the limitations in the SPA. Among other things, they argued that:

  • the buyer’s notice did not contain sufficient detail on the nature of its claims;
  • the notice did not summarise, as far as reasonably practicable, the amount claimed;
  • in some cases, it didn’t cover the substance of the claim at all; and
  • the sellers were not liable for the claim, because the buyer did not notify the claim within the two-year time period.

What did the court say?

The court agreed that there had been a breach of various warranties relating to environmental compliance, compliance with law generally and the accuracy of the company’s accounts.

Interestingly, the court was referred to the High Court’s decision in Dodika Ltd v United Luck Group Holdings Ltd [2020] EWHC 2101 (Comm), where the court dismissed a claim by a buyer under an SPA because the claim notice did not include sufficient detail of the claim. The decision in Dodika was overturned by the Court of Appeal while the High Court was deciding this case (see last week’s Corporate Law Update).

In the meantime, the High Court reached a similar conclusion here. The judge agreed that the SPA had “set a low threshold” which the buyer had met. The notice had stated a figure for the amount the buyer was claiming and made it clear that the figure represented the reduction in value of the shares caused by the warranty breaches. The buyer had summarised the amount so far as had been reasonably practicable at the time and has been under no obligation to explain how it had calculated the figure.

In the event, however, the level of detail in the claim notice was irrelevant. The contractual limitations on liability in the SPA did not apply, because the breaches of warranty had arisen from dishonesty or fraud by the sellers. In reaching this conclusion, the court addressed two interesting points.

  • Although it was the company’s actions, not the sellers’, that had led to the breaches of warranty, there had been wilful misconduct by one of the sellers in his position as a director controlling and running the company. The other sellers were also responsible for his misconduct, even if they had not acted dishonestly, because they had left the handling of the sale to him as their agent. (For the same reason, the other sellers were also liable for this particular seller’s fraudulent misrepresentations. See our update from last week.)
  • The two-year time limit on notifying a claim did not apply. The sellers had argued that the wording of the SPA was intended to delay the sellers’ liability, so that, once the buyer found out about the fraud, it had to notify the claim within the two-year time limited. The judge did not agree. He said it was “quite reasonable to suppose that any claim arising from the sellers' dishonesty should not be defeated by a contractual time bar”.

What does this mean for me?

This case is a useful reminder that it is critical for the seller of a company or a business to provide accurate responses to enquiries and to disclose fully and willingly against the warranties in the SPA. A seller should never deliberately withhold information from a buyer. To do so is to invite a claim following completion without the benefit of any negotiated contractual limitations.

The judgment also usefully underscores that the courts will take a sensible and pragmatic approach when deciding whether a buyer’s notice of claim contains sufficient detail to meet the requirements of the SPA. Although this will always depend on the precise wording of the contract, this and the decision in Dodika last week are indicative of a general direction of travel.

A buyer should always observe any notice requirements in the SPA and provide as much detail of the claim as is reasonably possible without limiting the avenues of claim available to it.

FRC launches first stage of scenario analysis project

Earlier this month, the Financial Reporting Council (FRC) announced that it was commissioning a new project to explore the use of scenario analysis by FTSE 350 companies. For more information, see our previous Corporate Law Update.

The FRC has now launched the first stage of that project, which takes the form of an online survey. The survey questionnaire asks participants about their motivation for conducting scenario analysis and their experience with a choice of data, scenarios and modelling, as well as about processes, governance and external communication.

The project is intended to investigate both climate-related and non-climate-related scenario analysis. The FRC has said that it intends to follow the online survey up with in-depth interviews with a representative sample of companies in May, June and July, and that it will analyse the extent of scenario reporting in 2020/21 annual reports.

FRC publishes research on FTSE 350 workforce engagement

The Financial Reporting Council (FRC) has published the results of a research study into workforce engagement by FTSE 350 companies.

The study was carried out in collaboration with Royal Holloway, University of London and the Involvement and Participation Association. The study focussed on 280 FTSE companies which each had at least 50 employees and consisted of a study of those companies’ annual reports, surveys of those companies and a series of interviews with directors, executives and workforce representatives.

The purpose of the study was to understand how in practice companies are applying Provision 5 of the UK Corporate Governance Code (the Code), which requires a company to put in place arrangements for its board to engage with its employees.

Provision 5 sets out three models – appointing a director from the workforce, establishing a formal workforce advisory panel, or designating a non-executive director (NED) with responsibility for workforce engagement – but companies can put in place alternative arrangements if they wish and explain why they are appropriate.

The following interesting points arise out of the study.

  • Based on a study of annual reports, of the companies covered by the study, 68% had adopted one of the three models set out in Provision 5 of the Code. Specifically, 40% of firms appointed a designated NED, 12% established an advisory workforce panel, and 16% combined both of these methods.
  • Results from the survey were slightly different, with 61% of companies that responded having appointed a designated NED and 17% establishing a workforce panel (either with or without a designated NED).
  • Only one company appointed a director from the workforce in direct response to Provision 5. (Four FTSE 350 companies had already adopted this model before Provision 5 came into effect.)
  • In response to the survey, 33% of firms said they adopted an “alternative approach”. However, according to the study, several firms that did this referred instead to a “colleague forum”, “sounding board” or “employee consultation group”, which the study notes sounds much like an advisory panel. It is possible, therefore, that the use of advisory panels is greater than it at first seems.
  • Other alternative approaches included site visits, town halls, staff focus groups, informal conversations with employees and annual employee surveys, approaches which the survey describes as “ad hoc arrangements”.

These levels are not substantially different from those reported by previous workforce engagement surveys. Usefully, however, this study provides more detail on why companies reached their decision to adopt a particular form of workforce engagement. It also provides commentary on other key themes relating to workforce engagement, including discussion at board meetings, interaction between different engagement models and employee representation, and outcomes, impact and feedback.

Finally, the study provides seven recommendations for firms looking to improve their workforce engagement methods. These include adapting arrangements to reach across a company’s hierarchy and to reflect the workforce’s geography and demography, creating a mechanism that permits frequent input from the workforce, allowing the workforce to elect their own representatives, and embedding an effective feedback loop to ensure better communication with the workforce.

Director did not breach duty by negotiating additional bonus for transferring employee

The High Court has held that a director of a company did not breach his duty to avoid a conflict of interest when he arranged an additional bonus for a key employee in return for signing up to the buyer’s new bonus scheme.

What happened?

Reader v SPIE Ltd [2021] EWHC 1221 concerned the sale of the shares in a company (G&L) that operated a plumbing business and a subsequent group reorganisation. The seller, who was an individual, was also a director of G&L.

During the sale process, the parties identified several key managers as being important to G&L’s business. As part of the transaction, the terms of those key managers’ service were to be transferred onto the buyer’s standard group terms. Those terms included a less generous bonus scheme than that offered by G&L.

In connection with this, the seller agreed in the agreement for the sale of the shares (SPA) to indemnify the buyer for any claims by the key managers arising out of changes made to the existing bonus scheme.

To ensure that the key employees agreed to the new terms, the seller (on behalf of G&L) negotiated a set of enhanced bonuses for the key employees. These were set out in a series of side letters, which were reviewed and approved by G&L’s other director independent of the seller.

Following the sale, G&L sold its business to another company within its group (SPIE). As part of that sale, the key employees’ service contracts transferred to SPIE under the Transfer of Undertakings Protection of Employment Regulations 2006, better known as “TUPE”.

In due course, SPIE declined to pay the enhanced bonuses. One of the key employees subsequently launched proceedings in the county court, claiming against SPIE for breach of the relevant side letter.

SPIE launched a counterclaim against the seller. It said that the seller had been under a fiduciary duty to G&L, when negotiating the side letters, not to place himself in a situation where he might have a conflict of interest. However, by negotiating the bonus enhancements, he had created new liabilities for G&L (and, subsequently, SPIE) while at the same time reducing his liability under the indemnity in the SPA (because the manager would not be motivated to claim in relation to the change to his bonus scheme arrangements).

The county court agreed and said the seller has been in breach of duty. It acknowledged that he had sent details of the proposed bonus enhancements to the director of G&L who was involved in approving the arrangements, but it said this was not enough. The seller should have brought the arrangements specifically to that director’s attention.

The seller appealed.

What did the High Court say?

The High Court upheld the appeal.

The judge noted that a fiduciary is required not to act where there is a conflict between their personal interest and their duty as a fiduciary. However, he also noted that this rule does not apply where the fiduciary receives the “fully informed consent” of their principal (in this case, G&L). In that case, although there may be a conflict of interest, there is no breach of duty. This is often treated as a duty to “fully and frankly disclose” any details necessary to inform the principal’s consent.

The key question here, therefore, was whether the seller had disclosed “adequate information about the changes made to the [key managers’] terms and conditions of employment” to G&L’s director.

The court said that he had. All G&L had needed to provide its fully informed consent was the set of terms proposed in the employee’s side letter. G&L had already known the amounts of the previous year’s bonuses and that the seller had a personal interest in putting new service agreements in place. Indeed, for this very reason the decision to approve the arrangements on behalf of G&L was taken independently by G&L’s other director.

The seller had disclosed “accurately and in full” the terms of the bonus and his interest in the arrangements, leaving it to G&L to decide whether to authorise the enhancements. As a result, the seller had not breached his fiduciary duty to avoid a conflict of interest.

What does this mean for me?

In some ways, the decision is unsurprising. The principle of full and frank disclosure is well established and this judgment shows that the courts will not be quick to impose additional requirements on a fiduciary where it is clear that the principal knows what is happening.

Conflicts of interest arise in various situations. This is particularly so within groups of companies, where the same people may serve a directors of numerous group companies. Key things for a director or other fiduciary to bear in mind include the following.

  • Seek approval for any “situational conflicts”. These arise where a director has some longer-term interest of some kind that impact on the decisions they make as a director. Examples might include where the director is the company’s landlord or tenant or holds shares in a competitor. A director is under a duty in section 175 of the Companies Act 2006 to avoid situational conflicts. However, a company can, after careful consideration, approve a situational conflict, either through its shareholders or, where possible, through its board.
  • Declare any interest in a transaction involving the company. Often known as a “transactional conflict”, a director is required by section 177 of the Companies Act 2006 to declare any personal interest in a transaction involving the company. A similar requirement may also arise under the company’s articles of association. A director should provide extensive details of the conflict, including copies of any relevant documentation, to ensure there is “full and frank disclosure”.
  • Consider recusing yourself. After declaring a transactional conflict, a director should check the company’s articles to see whether they are entitled to take part in the decision-making process (that is, to attend the relevant board meeting and vote on the matter). Even if they are, unless the matter is straightforward, the director should give serious consideration to recusing themselves so as to avoid any suggestion of impropriety or influence.

There is also a lesson in this judgment for principals (whether companies or other commercial parties) to review carefully any materials or arrangements before committing to them and to raise questions on any matters of uncertainty.

Also this week…

  • UK Endorsement Board receives statutory powers. New regulations have been made to delegate the Government’s powers to adopt international accounting standards (IAS) for use in the UK. The need to adopt IAS within the UK arises out of the UK’s withdrawal from the European Union at the end of 2020. Responsibility for developing new standards will now rest with the UK Endorsement Board (UKEB), which was established earlier this year. The UKEB will report to the Government and the Financial Reporting Council.
  • FRC launches survey on XHTML reporting. The Financial Reporting Council (FRC) has launched a new survey to gauge how ready companies are to publish their annual reports in XHTML format and to understand the experience of companies that have already trialled or published XHTML annual reports. Under Rule 4.1.14R of the Financial Conduct Authority’s Disclosure Guidance and Transparency Rules, companies whose securities are admitted to a regulated market will be required to publish their annual reports for 2021 in XHTML format in accordance with the UK version of the European Single Electronic Format Regulation.

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