Corporate Law Update

This week:

• The court sanctions a cross-border insurance reorganisation combining a Part VII insurance business transfer with an EU cross-border merger
• The court allows a shareholder to bring a derivative claim against a company’s directors and administrators in the context of a pre-pack administration
• Entire agreement clauses do not automatically exclude liability for misrepresentation after all…
• A few other items of interest

Court sanctions cross-border Brexit-led insurance business transfer

The court has sanctioned the transfer of an insurance business from a UK entity to a Luxembourg entity using a combination of the Part VII procedure in the Financial Services and Markets Act 2000 (Part VII) and the cross-border mergers (CBM) regime.

What happened?

In Re AIG Europe Limited, the European arm of a global insurer had concluded that, in light of current uncertainties, in order to prepare for the UK’s forthcoming withdrawal from the European Union, it needed to transfer certain of its non-UK insurance business within the European Economic Area (EEA) and Switzerland (the EEA business) to a new group company incorporated within the EEA but outside the UK.

This would allow the insurer to continue to service its EEA business following Brexit, when it may no longer be able to rely (as it does currently) on the EU passporting regime.

Ultimately, the insurer chose to transfer its EEA business to a company incorporated in Luxembourg. At the same time, it decided to transfer its non-EEA insurance business to a new UK group company.

To achieve this, the insurer applied to the court to sanction the transfers under Part VII. Part VII is a flexible statutory regime that allows a company to transfer a UK banking or insurance business without having to get consent from each individual customer or policyholder to transfer (or novate) the policy to the new company.

Although a Part VII transfer alone should have been sufficient to transfer the EEA business to the Luxembourg company, the insurer wanted to maximise the likelihood that that transfer would be recognised in Luxembourg. To do this, it applied to combine the Part VII transfer with a merger under the EU CBM regime, something which has never been done before.

What did the court say?

The court acknowledged that a Part VII transfer involving an EU CBM was “novel”. However, the judge had “no doubt” that it was permissible to combine the two regimes in this way.

The judge also found that the scheme was a “reasoned response” to the uncertainties of Brexit and was motivated by the desire to ensure that policyholders under the EEA business could still be serviced in the future. He was therefore happy to sanction it, particularly given that neither the Financial Conduct Authority nor the Prudential Regulation Authority had raised any objections.

Practical implications

The decision is helpful for businesses that are looking to restructure their operations and may, for whatever reason, find it useful to utilise more than one statutory procedure. In this case, there was a clear rationale for engaging the CBM regime.

The combination of a Part VII scheme and a CBM may well be of historic interest going forward. This particular scheme was driven by Brexit planning. Following Brexit, the same imperatives may no longer apply, and the CBM regime will in any case no longer be available to UK companies (unless the UK and the EU agree otherwise by treaty).

However, the decision nonetheless demonstrates the flexibility the UK courts are prepared to show to facilitate reorganisations with a genuine commercial rationale.

Court allows derivative claim on pre-pack administration to proceed

The court has decided to allow a shareholder to pursue a derivative claim on behalf of a company that was placed into a pre-pack administration.

What happened?

Montgold Capital LLP v Ilska and others involved a restaurant company which was placed into a “pre-pack” administration, under which its entire business was sold, in late 2016.

One of the company’s shareholders, who held 50 per cent of the company’s shares, launched derivative claim proceedings on behalf of the company. It claimed that the pre-pack had been engineered to hinder a sale of the business to the shareholder’s ultimate controller and that the price ultimately paid on the pre-pack significantly undervalued the business.

The court had to decide whether to allow the derivative claim to continue.

What is a derivative claim?

A derivative claim is a mechanism by which a shareholder of a company can bring an action on the company’s behalf in respect of a cause arising from an actual or proposed breach of duty or trust, negligence or default by one or more of the company’s directors. A shareholder would normally do this if the board has declined to bring an action in the company’s name. Although a derivative claim is initiated by a shareholder, it is a claim by the company, and any compensation awarded by the court belongs to the company (not the shareholder).

In this case, the shareholder sought to bring a claim against a total of nine persons, comprising two of the company’s directors and one of their service companies, another shareholder (who held 45% of the company’s shares), the buyer in the pre-pack sale and its CEO, an allegedly connected insolvency practitioner, and the two administrators of the company.

The court must decide whether a shareholder is allowed to bring a derivative claim. The Companies Act 2006 sets out various tests the court can apply in making its decision. Indeed, in some circumstances, the court has no choice and must refuse to allow the claim.

What did the court decide?

The court allowed the claim to continue. This does not mean that the claim succeeded, but rather that the shareholder is now allowed to bring it at a full trial.

In making its decision, the court weighed up various factors, including the size of the claim (which it said was significantly greater than £125,000), the strength of the claim (which it said amounted to a reasonable case, despite the allegations being inherently improbable) and the ability of the defendants to satisfy any judgment against them (they were individuals of “means”).

The court was also content that the claim would not impact on the company if it were to lose, and that the costs of bringing and funding the proceedings were no impediment, particularly because the shareholder bringing the claim had put in security for the defendants’ costs and had not asked for any indemnity from the company’s assets.

Practical implications

From a general perspective, the decision is useful guidance on how a court will approach the various factors it needs to consider when deciding whether to permit a derivative claim to proceed.

Perhaps more interesting, the case is a reminder that shareholder claims and claims under companies legislation remain relevant when a company enters insolvency proceedings. Once a company enters the “zone of insolvency”, its directors have an overriding duty to act in the interests of its creditors who sit in priority to shareholders on a distribution of assets. This can make it tempting, psychologically, to relegate the interests of shareholders in these circumstances and focus purely on creditors.

However, as the decision shows, it can be risky to leave the shareholders out of consideration completely, particularly where the administration is carried out quickly, as on a “pre-pack”.

In this case, the shareholder argued that the company’s unsecured creditors may well recover 100 pence in the pound if its claim succeeded, rather than the 40 pence they were likely to receive if it did not. This would likely also leave some assets available for the company’s shareholders. The court found this argument powerful.

The decision also highlights that the duties of directors are complex. While the decisions to sell the business and, if so, at what price might be solely ones for the administrators, the decision to appoint the administrators who will facilitate the sale is still one for the directors. The directors should not assume that there can be no adverse repercussions for them if they do not comply with all of their own duties, nor consider carefully in doing so to whom those duties are owed.

Entire agreement clause did not exclude misrepresentation claims after all

The court has overturned its own initial decision on strike-out and confirmed that an entire agreement clause did not exclude claims for misrepresentation.

What happened?

In June, we reported that a master in the High Court had ruled that a buyer of shares was unable to bring a claim in misrepresentation against the seller, because the share sale agreement contained an “entire agreement clause”.

The master reached this decision on the basis that the agreement already provided specific remedies (in this case, indemnities) for the kinds of loss that could be recovered through a misrepresentation claim. In his view, this showed that the parties had intended to exclude liability for misrepresentation.

The decision was surprising at the time, as the courts had historically refused to find that entire agreement clauses have this effect. Instead, they had held that clear wording is needed to exclude claims in misrepresentation. We also noted that the judgment was merely a decision on a “strike-out application”, and that it was important not to give it too much weight at that stage.

The defendant appealed the decision on strike-out. After considering the issue in the appeal (Al-Hasawi v Nottingham Forest Football Club Ltd), the High Court overturned the decision made in the initial strike-out application and said that the entire agreement clause in the sale agreement did not exclude claims for misrepresentation after all.

In short, the judge said that the fact that parties may provide for specific remedies in their contract does not automatically mean that they intend to exclude other remedies.

Practical implications

To the extent that the original decision changed the law on this point in any way, the decision on appeal has undone that.

Contractual parties should now assume once again that an entire agreement clause will not automatically exclude liability for misrepresentation. Instead, if parties want to exclude this kind of liability, it is still best to state this specifically and expressly in the contract. For added measure, parties may also consider including a “non-reliance” clause.

Other items

• Corporate governance. Institutional Shareholder Services (ISS) has published updates to its UK Proxy Voting Guidelines for 2019. As expected, the new guidelines recommend voting against the appointment of an external auditor where the lead audit partner has been linked with a significant auditing controversy. The updates also contain new guidelines on director elections, remuneration policies and reports, and long-term incentive plans (LTIPs).
• Corporate governance. Glass Lewis has published its 2019 UK Proxy Paper Guidelines. Among other things, the new guidelines state that Glass Lewis may hold committee chairs and members to account for failing to adequately address shareholder dissent. It will also take disclosed gender pay gap information and executive pipeline composition into account when assessing board diversity. However, CEO pay ratios will not, in and of themselves, impact any voting recommendations.
• Capital markets. NEX Exchange (NEX) has published a disciplinary notice in which it has sanctioned a corporate adviser for breaching paragraph 32 of the NEX Exchange Corporate Adviser Handbook. The adviser failed to ensure that an issuer complied with the Rules for Issuers, to ensure information provided to NEX was accurate and complete, to act with due care, skill and competence, and to avoid impairing the reputation and integrity of the Exchange.
• Audit reviews. The Financial Reporting Council (FRC) has announced that it will be supplementing its 2019/2020 audit quality review with two “thematic reviews”. The first will assess how audit firms have developed and use “audit quality indicators” (AQIs), quantitative measures designed to measure the quality of audits. The second will focus on the use of technology (particularly data analytics) in audit and its impact on audit quality. At the same time, the FRC is seeking feedback to support the post-implementation review of its 2016 changes to ethical and auditing standards.