Corporate Law Update

• A company was able to justify a demerger distribution by reference to accounts, even though they contained errors and overvalued or omitted certain assets
• The court examines whether a request by shareholders to move resolutions at a company meeting was “vexatious”

Court considers whether demerger by dividend was valid (part 2)

Last week, we began our analysis of Burnden Holdings (UK) Limited v Fielding and anor, in which the High Court said that a company had validly distributed shares in a subsidiary to its shareholder, notwithstanding several alleged defects in declaring the distribution.

In particular, we looked at whether the accounts used to justify the distribution had to be set out in a single document for the distribution to be valid.

This week we look at whether certain discrepancies in the figures in those accounts were material enough to render the accounts invalid.

What happened?

As a reminder, the purpose of the distribution was to sell down a proportion of the shares in one of the company’s subsidiaries to a third party, ultimately (although indirectly) generating cash for the company. Within a year of making the distribution, the company was placed into administration. A year later, it entered compulsory winding-up.

The liquidator tried to claw the distribution back. Among other things, he claimed that the distribution was invalid because the accounts used to justify it misstated the value of, or omitted completely, certain line items.

As we noted last week, the company used “interim accounts” to justify the distribution. Interim accounts can take any form, but they must enable someone to form a reasonable judgment of the company’s assets, liabilities, profits, losses, share capital and reserves and certain provisions.

The liquidator alleged that the accounts misdescribed the company’s assets and liabilities in seven respects. In particular, he alleged that the shares in two of the company’s subsidiaries had been overvalued, that two loans had been given a substantial value but were in fact irrecoverable, and that the accounts missed out provisions for lease liabilities and legal fees.

As a result, the liquidator claimed, the accounts did not allow a reasonable judgment to be made and so were not valid interim accounts.

What did the court say?

A large part of the judgment is dedicated to deciding whether individual items were in fact undervalued, overvalued or simply omitted, which it is not necessary to go into in detail.

In short, the court said that the accounts provided a sufficient level of detail to enable a reasonable judgment to be made. They therefore qualified as interim accounts.

In particular, the judge noted the following:

• The fact that certain amounts in the accounts had to be “amalgamated” to produce accurate figures did not invalidate them.
• Certain items had been “misdescribed” in the accounts (e.g. because the description of a figure relating to shares or a loan referred to the wrong company). However, had these been the company’s annual accounts, they would have shown an aggregate figure, which would not have been affected by this kind of misdescription. The misdescription was therefore immaterial.
• The carrying figure given for the shares in a subsidiary was higher than their actual value (and so was overstated). However, there was no requirement to impair that figure in the accounts and, even if there had been, it would not have resulted in a realised loss preventing the distribution.
• Even if that undervalue did need to be treated as a realised loss, it would not have been recorded as one, because it was dwarfed by corresponding understatements in the value of other assets. No realised loss would therefore ever have been recorded.
• The accounts failed to include a liability for legal fees. However, that was because, when the accounts were drawn up, the intention was for one of the shareholders to bear those fees, not the company. They therefore did not need to figure in the accounts.

Importantly, the judge confirmed that, strictly speaking, interim accounts of a private company do not need to conform to the same standard as annual accounts.

Statute expressly requires interim accounts drawn up by a public company to give a “true and fair view” of the company’s state of affairs. However, previous case law (BTI 2014 LLC v Sequana) had suggested that even private company interim accounts had to meet this threshold, or else they would not permit a reasonable judgment of the items in them.

However, in this case, the judge said that whether a private company’s interim accounts give a true and fair view is simply a “relevant factor” in deciding whether they enable a reasonable judgment to be made. It is important, but not determinative.

What does this mean for me?

There is no substitute for ensuring interim accounts are accurate, properly state the value of assets and liabilities and include all necessary items. Any errors may attract scrutiny and require some explanation. In this case, the judge devoted 124 paragraphs to analysing the various discrepancies in the company’s accounts before concluding they did not affect the distribution.

On the other hand, the decision suggests courts may be willing to adopt a pragmatic approach to examining interim accounts. For example, the judge was prepared essentially to disregard mistakes in the accounts that were not relevant to the company’s distributable profits.

The judgment is also helpful in clarifying that the strict test of “true and fair view” does not apply to interim accounts drawn up by private companies. However, the judge’s comments show that private companies are still expected to meet a high standard when producing interim accounts.

If using interim accounts to justify a dividend or other distribution, directors should ask the following:

• Do the accounts allow a reasonable judgment to be made of the company’s assets, liabilities and provisions, profits and losses, and share capital and reserves? How can this be shown if the accounts do not give a “true and fair view” of the company’s affairs?
• Have the accounts been prepared consistently with the company’s accounting standards? In particular, has the company applied the same principles when booking the value of assets?
• Are the accounts accurate? Do they properly state the value of assets and liabilities? Do any descriptions in the accounts match up with the items for which figures are given?

Court examines whether general meeting requisition was “vexatious”

The High Court has examined whether shareholders of a company who requisitioned a general meeting had done so to propose resolutions that were “vexatious”.

What happened?

Kaye v Oxford House (Wimbledon) Management Company Limited concerned a dispute between the management company of a block of apartments and one of its residents over whether a small piece of land was included within the resident’s long lease.

At the time the litigation began, the company’s board comprised six individuals (the “original directors”), none of whom included the resident in question, his spouse or anyone close to him. Those directors caused the company to bring proceedings against the resident on the grounds that he had begun to occupy the parcel of land without permission.

In response, the resident claimed the parcel was always intended to form part of his lease, or that over time it had become part of his lease. Alternatively, he argued, he should be allowed to use the parcel under an easement or under a doctrine known as “proprietary estoppel”.

A few months after the proceedings began, a person sympathetic to the resident requisitioned a general meeting of the company to remove its board and install five new directors, including the resident himself. They were successful and the board was effectively replaced. As a result, the resident was both a director of the company and the defendant in proceedings against it.

The next day, the board began steps to negotiate and settle the proceedings. Over the next few weeks, three of the new directors resigned, in one case after receiving legal advice the resident’s claim was without merit (suggesting that the company should not settle). The two remaining directors (still including the resident) appointed a further director (the wife of one of those directors) and, together, the three of them continued to take steps to settle the claim.

The contentious meeting

This culminated in three of the original directors, in their capacity as shareholders of the company, requisitioning a general meeting of the company under section 303 of the Companies Act 2006 (the “Act”). They proposed resolutions to remove the three directors and install themselves and four other individuals as directors of the company – effectively, to wrest back control of the company.

The company called the general meeting as required by law. (Under section 304 of the Act, a company has 21 days from receiving a requisition notice to call the general meeting.)

Subsequently, the resident (still a director) took advice from a barrister on whether the resolutions proposed by the old directors were “vexatious”. Under section 303(5)(c) of the Act, members cannot requisition and move a resolution at a general meeting if the resolution is “frivolous or vexatious”. (The resident did not ask for advice on whether the resolutions were frivolous.)

The barrister’s view, based on the information provided to him, was that the resolutions were indeed vexatious. On this basis, when the general meeting opened a few days later, the resident, who was acting as chairman of the meeting, declared the resolutions vexatious, claimed to close the meeting immediately and then left.

The other shareholders at the meeting disagreed with this decision. They declared the closing of the meeting invalid and purported to continue the meeting. All of the resolutions were passed.

This naturally created a dispute over whether the meeting was validly closed. The resident argued that, based on previous case law, even if the resolutions were not vexatious, he had taken legal advice on the matter in good faith and so his decision to close the meeting had to stand.

The requisitioners, however, argued that the company needed to have decided whether the resolutions were vexatious before it called the meeting. Once it had called the meeting, the chairman had to allow the resolutions to be voted on. He could no longer decide to withdraw them on the grounds that they were vexatious.

The court therefore had to decide three questions:

• Were the resolutions proposed by the requisitioners “vexatious”?
• If so, was the resident (as chairman) allowed to withdraw the resolutions from a vote once notice of the meeting had been given and the resolutions circulated?
• Even if the resolutions were not vexatious, was the resident’s decision to close the meeting effective because he honestly believed they were?

If the answer to any of those questions was yes, the attempt to replace the board would have failed.

What did the court say?

In short, the court said that the resident had not been entitled to withdraw the resolutions and close the meeting. The resolutions were validly passed and the board had been replaced.

The judge’s reasoning is interesting. In particular, he made the following points:

• A company must decide whether a resolution is “vexatious” when it receives the request to call a general meeting. If it calls the meeting and includes the resolution in the notice, it will be taken to have accepted it. The chairman of the meeting cannot later withdraw the resolution without the consent of the meeting.
• A chairman cannot close a general meeting when there is proper business still to be conducted. The judge rejected the concept that a chairman’s decision to close the meeting is valid, even if it is made on incorrect premises, provided that the chairman is not acting neglectfully or in bad faith (although it so happened in this case that the chairman had acted neglectfully).
• A resolution is likely to be “vexatious” if it is “troublesome”, “burdensome” or proposed for “no proper purpose”. This has to be judged from the company’s perspective, not the directors’. However, the judge suggested that the ability to appoint and remove directors is a “fundamental right of members”, and a resolution to achieve this effectively cannot be vexatious. It is worth noting that the judge’s comments on this point appear to be obiter, and so do not create binding law, but they will nonetheless be persuasive in future decisions.

What does this mean for me?

Although the facts in this case were rather peculiar, battles for board control are not uncommon. The judgment in this case suggests that a recalcitrant board facing ejection is highly unlikely to be able to bat away resolutions for their removal on the grounds they are vexatious (or, presumably, because they are frivolous).

The decision also highlights the need to consider any resolutions requisitioned by members as soon as they are received, it will not be possible to withdraw them once notice of the meeting has been given.

It is worth noting that a company can also refrain from putting a resolution to a meeting if it is defamatory, or if it would be ineffective if passed.

A board that receives a requisition should therefore ask itself the following questions:

• Is the resolution one which is contemplated or permitted by statute or the company’s constitution? If not, it may well be of no force or effect and the company may be able to omit it.
• Is the resolution inflammatory? Does it target any individuals or contain unsupported allegations against anyone? If so, the company may be able to refuse to move it on the basis it is defamatory.
• Have the members requisitioning the resolution done so merely to block or impede the board or to pursue some kind of personal vendetta? Are they using the procedure to gain publicity for themselves or to or create a nuisance? If so, the resolution may well be vexatious.
• Are any of the proposed resolutions to appoint or remove directors? The judge’s comments in this case suggest that it is highly unlikely, if possible at all, for these kinds of resolutions ever to be vexatious. If a company does genuinely believe it is entitled to reject this kind of a resolution on this basis, it will need strong and incontrovertible evidence to justify its decision.