Corporate Law Update

This week:

• The Court of Appeal finds that a requirement in a share purchase agreement to give details and an estimate of a claim did not apply to a claim under an indemnity
• The final set of principles of corporate governance for large private companies is published
• Companies House has announced that it will start vetting applications to incorporate legal entities to ensure that any new entity is not linked to any individuals subject to sanctions
• The Quoted Companies Alliance (QCA) has published a review of corporate governance behaviour and compliance among AIM companies during 2018
• A few other items of interest

Court interprets indemnity clause in share purchase agreement

The Court of Appeal has held that a notice of claim under an indemnity in a share purchase agreement was valid and was not subject to a specific requirement to state an estimate of the amount claimed.

What happened?

Hopkinson v Towergate Financial (Group) Limited concerned the sale of the shares in a financial services company selling products to retail customers.

As part of the sale, the sellers agreed to indemnify the buyer and its group companies against any claims arising out of investigations launched by the Financial Services Authority (FSA) (now the Financial Conduct Authority) into (among other things) mis-selling of certain financial products. This included losses arising from a review that the FSA had already commenced.

The share purchase agreement (SPA) also contained a limitation on the sellers’ liability, which read as follows (with our emphasis):

“6.7 The Purchaser shall not make any Claims against the Warrantors nor shall the Warrantors have any liability in respect of any matter or thing unless notice in writing of the relevant matter or thing (specifying the details and circumstances giving rise to the Claim or Claims and an estimate in good faith of the total amount of such Claim or Claims) is given to all the Warrantors as soon as possible and in any event prior to:
6.7.1 the seventh anniversary of the date of this Agreement in the case of any Claim solely in relation to the Taxation Covenant;
6.7.2 the date two years from the Completion Date in the case of any other Claim; and
6.7.3 in relation to a claim under the indemnity in clause 5.9 on or before the seventh anniversary of the date of this Agreement.”

Finally, the SPA defined “Claim” as a claim under the warranties or the tax covenant contained in the SPA. Importantly, the defined term “Claim” did not include claims under the mis-selling indemnity.

In due course, the buyer notified the sellers that it intended to claim under the indemnity in relation to potential mis-selling claims arising out of the FSA’s review. The sellers rejected the claim because (among other reasons) the notice had not given details of any claims under the indemnity, nor any estimate of the amount claimed, as required by bracketed words in clause 6.7.

What did the court say?

The court said the notice of claim was valid.

In particular, it said that the notice did not need to set out an estimate of the claim in order to be valid. The wording in brackets referred to a “Claim”, which, as defined in the SPA, included warranty and tax covenant claims, but did not include claims under the mis-selling indemnity.

The sellers argued that the court should interpret the word “Claim” widely so as to include claims under the indemnity, especially because the rest of the clause clearly did apply to the indemnity.

The court disagreed. It said the right starting point was to assume that “parties who have entered into a professionally drafted agreement in which terms have been elaborately defined intend to use such terms in accordance with the definitions”. This echoes comments in the recent high-profile case of Wood v Capita Insurance. The court felt that, although the limitation had not been drafted particularly well, it was clear from the use of the defined term “Claim” that the bracketed part of the clause did not apply to claims under the mis-selling indemnity.

This interpretation caused the clause to come into conflict with another part of the SPA (the tax covenant). To resolve this, the court replaced the words “Taxation Covenant” in clause 6.7.1 (which had not been defined) with the words “Tax Warranties” (which had). In doing so, the court referred to comments in another recent but often criticised judgment – Chartbrook v Persimmon Homes – in which the House of Lords said that, where the language of a contract has gone wrong, there is “[no] limit to the amount of red ink or verbal rearrangement or correction which the court is allowed”.

Practical implications

This judgment makes it crystal clear how important it is to draft contractual clauses carefully. Quibbles over grammar and punctuation are often seen as lawyers merely indulging in pedantry, but, in the end, it was the use of capital “C”, rather than lowercase “c”, that made all the difference. As the decision shows, the wrong use of a defined term can have significant consequences.

The case might also mark a possible trend towards a more “literal” interpretation of contracts.

In the landmark case of Investors Compensation Scheme, the House of Lords told us that the meaning of a document is not always the same as the meaning of its words, a doctrine sometimes called “contextualism”. In Rainy Sky, that approach was tempered, with the court proposing a balanced approach that looks at both the wording of a contract and the context surrounding it.

But other cases, such as Arnold v Britton and Wood, suggest that the courts are in fact giving significant weight to the actual words of a contract. It is perhaps this that prompted Chancellor of the High Court Sir Geoffrey Vos to comment last year that sometimes judges “say one thing and do another”. And in a speech to Oxford University last year, former Supreme Court judge Lord Sumption called for judges to “reassert the primacy of language” and not to “overstate [the] flexibility” of language. In this case, the court’s insistence that “Claim” meant “Claim”, and not “claim”, might be an example of that mind-set being put into practice.

The key take-away: when drafting a contract, choose your words wisely.

Private company corporate governance code published

The Financial Reporting Council (FRC) has published a new set of principles of corporate governance for large private companies.

The Principles have been designed in part to assist very large unlisted companies with meeting their new obligation for financial years beginning in 2019 to report against a corporate governance code of their choosing. This new requirement will apply to unlisted UK companies (including subsidiaries of publicly traded companies) that have more than 2,000 employees, or both a turnover of more than £200 million and a balance sheet total of more than £2 billion.

The document follows a draft published in June and deliberately takes the form of a set of high-level principles designed to suit a wide range of companies. The idea is for companies to explain their approach to applying each of the Principles, rather than “comply or explain” in the way that publicly traded companies do against the provisions of the UK Corporate Governance Code.

The six Principles are:

• Purpose and leadership. The directors should promote a well-developed and defined purpose, leading by example, engaging with stakeholders and setting a tone from the top. They should monitor company culture and articulate the strategy and business model throughout the company.
• Board composition. The company’s board should have an effective chair and a balance of skills, backgrounds, experience and knowledge that promotes diversity. The size of the board should match the scale and complexity of the company, directors should be regularly evaluated, and companies should consider the value of appointing non-executive directors.
• Director responsibilities. Companies should implement policies that clearly set out their directors’ authority, accountability, role and conduct. Boards should encourage internal challenge and establish robust internal procedures to ensure systems and controls operate effectively.
• Opportunity and risk. The board should consider how the company creates value over the long term and identifies future opportunities for innovation.  It should oversee how risks to the company (including reputational risk) are managed, which should include establishing an internal control framework and may include delegating responsibility to a committee.
• Remuneration. Director and senior manager remuneration should be aligned with performance, behaviours and achieving the company’s purpose and values. There should be clear policies to enable accountability to shareholders, and some boards may wish to create a remuneration committee to design executive remuneration structures.
• Shareholder relationships and engagement. Directors should foster effective dialogue with stakeholders to understand the effect of the company’s practices and re-align strategy. These stakeholders will include the company’s workforce, customers and suppliers, but may also include regulators, governments, pensioners, creditors and community groups. In particular, the company should establish a range of formal and informal channels for communicating with its workforce.

Government announces changes to limited partnership law

The Government has published proposals to reform limited partnership (LP) law in order to protect against LPs being used for criminal purposes (including money laundering). The proposals follow the Government’s original consultation in April 2018 and its call for evidence in January 2017.

The key points to note are as follows:

• Anyone wishing to register an LP in the future will need to provide evidence that they are registered with an anti-money laundering (AML) supervisory body. The Government is considering how to achieve this for applicants based overseas, but it may end up limiting overseas applications to jurisdictions within the European Economic Area (EEA).
• An LP will need to maintain a demonstrable link to the UK. It could do this in one of three ways: keep its principal place of business in the UK; engage a UK agent registered with an AML supervisory body; or show it is conducting some legitimate business activity at a UK address. As our partner Stephen Robinson explains in his blog, this flexibility will come as a relief for many funds operating in the private equity and venture capital sectors.
• All LPs will be required to file an annual confirmation statement. (Scottish LPs already do this.) However, the Government has decided not to require all LPs to file accounts. (Some LPs are required to file accounts, but most funds are structured in a way that does not require this.)
• Companies House will have the power to strike dormant LPs off the public register. This would happen only if the LP has been dissolved or is not carrying on business. This process would be subject to a “robust notification procedure”, which the Government will continue to design, to ensure limited partners in particular are aware of a proposed strike-off.

The Government now intends to develop legislation to implement these reforms.

QCA publishes report on AIM corporate governance in 2018

The Quoted Companies Alliance (QCA) has published its latest review of corporate governance behaviour during 2018. Together with UHY Hacker Young, the QCA analysed corporate governance disclosures by 50 AIM companies and 10 NEX Exchange companies to identify patterns, although the report covers only the 50 AIM companies sampled.

The review also examines the impact of the changes to AIM Rule 26, which came into effect fully in September. Rule 26 requires AIM companies to identify a “recognised corporate governance code” and to explain any respects in which the company diverges from that code. In practice, most AIM companies (98 per cent of companies sampled) adopted the QCA Corporate Governance Code.

Key findings from the review include:

• The change to Rule 26 appears to have brought about a “marked level of improvement in the level of disclosure”. The number of disclosures was significantly higher after the rule change, particularly in relation to independent directors and board performance.
• Notably, before the rule change, only 24 per cent of companies sampled explained how their board embeds ethical values and behaviours. Following the rule change, this has jumped to 80 per cent. Likewise, previously only 10 per cent of companies sampled explained how their culture is consistent with their objectives, strategy and business model, whereas now 62 per cent do so.
• In other areas progress was less marked. The proportion of companies sampled that explained how their directors maintain their skills sets rose from 4 per cent to 32 per cent due to the change, and the proportion that described their board evaluation process rose from 4 per cent to only 12 per cent.
• The lowest levels of compliance related to explaining external advice given to the board (8 per cent), how the board evaluation process was conducted (8 per cent), plans for evolving the company’s governance framework (9 per cent), and explaining significant votes against resolutions (2 per cent).

The review also includes five “top tips” for AIM company boards when seeking investment. These including nailing the elevator pitch, asking for shareholder feedback, knowing the board’s purpose, showing how the company differs, and celebrating the company’s culture.

Other items

• Company and LLP incorporations. Companies House has announced that, with effect from 12 December 2018, it is now vetting applications to incorporate or register certain kinds of legal entity (including companies and LLPs) to ensure they do not breach UN financial sanctions. It will check the details of each connected individual against the Treasury’s list of sanctioned individuals and, if there is a sufficient match, reject the application. It is possible to re-submit an application, but the applicant will need to include evidence that the individual in question is not subject to sanctions.
• Directors’ remuneration. The GC100 and Investor Group have published a revised version of their Directors’ Remuneration Reporting Guidance. The changes reflect the new content requirements for a publicly traded company’s remuneration report that come into effect next year, which include CEO pay ratios, links to share-price appreciation and any exercise of discretion over director pay awards.
• AIM. The London Stock Exchange has publicly censured an AIM company for breaching AIM Rules 11 and 31. The company in question had entered into an exclusivity fee undertaking in connected with a potential reverse takeover without notifying the market, despite having been advised to do so by its nominated adviser, and without providing all relevant information to its nomad. The company was also fined £700,000 (discounted to £490,000 for early settlement).
• Market abuse. The draft Market Abuse (Amendment) (EU Exit) Regulations 2018 have been published. As expected, the Regulations would adapt the EU market abuse regime to ensure it continues to operate properly in the UK. Significantly, and as we noted in a previous update, the amended regime would apply to all regulated markets, multilateral trading facilities (MTFs) and organised trading facilities (OTFs) located either in the UK or in an EU member state.