Corporate Law Update

In this week's update: no claim under a tax covenant until the tax is payable, an individual was not a "de facto" director, updates to the AIM Rules and a few other items.

A buyer could not bring a claim under a tax indemnity because the underlying tax liability had not yet become “payable”
The court finds that an individual was not a de facto director of a company
The London Stock Exchange has published changes to its rulebooks that will come into force when the EU Prospectus Regulation takes effect
A few other items of interest

Buyer could not claim under tax covenant until tax become payable

The Court of Appeal has held that the buyer of a business could not claim against the seller under a tax covenant to recover VAT, penalties and interest for which the business had been assessed, because they had not yet become “payable”.

What happened?

Minera Las Bambas SA v Glencore Queensland Limited concerned the sale by Glencore of the shares in Xstrata Peru SA to Minera las Bambas. Xstrata Peru headed a small group that operated a mine in Peru. (Readers may recall that we reported on this case in March last year in relation to withholding documents in legal proceedings.)

As is common, the contract for the sale of the shares (the SPA) contained a tax covenant, designed to protect Minera against any historic tax liabilities relating to the target business. In particular, the SPA required Glencore to indemnify Minera against (with our emphasis added):

the amount of any Tax payable by a Group Company to the extent the Tax has not been discharged or paid on or prior to the Effective Time and it . . . relates to any period, or part period, up to and including Closing.

After the deal closed, the Peruvian tax authorities levied an assessment on the business, claiming that it had failed to pay certain amounts of Peruvian value added tax (VAT), and that it had wrongly claimed certain VAT refunds. The assessment required Xstrata Peru to pay (or repay) the relevant VAT, along with interest and penalties.

Importantly, under Peruvian law, a tax assessment creates an actual liability to pay tax immediately after it is issued. However, the Peruvian authorities cannot enforce that liability unless all rights of appeal before the Peruvian courts have been exhausted.

In the event, Xstrata Peru paid the amounts claimed by the Peruvian authorities, but at the same time preserved its right to appeal the assessment. Part of the payment was funded by Glencore, and the balance by Minera. Xstrata Peru did appeal the assessment, and the appeal has yet to be decided.

In the meantime, Minera brought a claim against Glencore to recover the amount of the tax payment it had funded. It said that the VAT repayment had become “payable” when its amount and existence had been established, which happened when the Peruvian authorities issued their assessment.

Glencore, on the other hand, said the VAT repayment would become “payable” only when it could actually be enforced, and that this could not occur until Xstrata Peru’s appeal had been decided.

What did the court say?

The court agreed with Glencore. In reaching their decision, the three judges had to decide what the parties mean by the word “payable”. To do this, they employed the traditional methods of interpretation that were most recently summarised in the key case of Capita v Wood.

Ultimately, the court decided that, in the SPA between the parties, the word “payable” meant that an “enforceable obligation to pay an amount of tax” had to arise, and not merely that “a liability to pay an amount of tax”. In its reasoning, the court made the following interesting comments:

The word “payable” is not a legal term, and it was no use analysing how the courts had interpreted it historically in other contracts. Both parties had tried to point to previous decisions that considered the word, but the court was not interested.
Glencore was required to “indemnify” Minera, which (under English law) meant to prevent Minera from suffering any loss. But because the VAT repayment had not yet become enforceable, it was not possible to say that Minera had suffered any loss.
Finally, it made no sense to require Glencore to pay under the indemnity, when the final result might yet be that neither Glencore nor Xstrata Peru would ever need to pay the tax.

What does this mean for me?

This seems to be the right decision, but it highlights some important things to consider when drafting a tax indemnity or, indeed, any other kind of indemnity:

What should the trigger for payment be? Should it be when the underlying liability becomes enforceable, or some earlier stage? As this case shows, using words such as “payable” can create uncertainty. Parties should consider setting out specific triggers, such as delivery of a notice, assessment or invoice, that will activate the indemnity.
How should the indemnity be phrased? The word “indemnity” has a rather loose meaning in English law: to compensate someone for loss they have suffered. Contrary to what parties often assume, it doesn’t automatically create a debt. That distinction formed an important part of the court’s reasoning here. If the indemnity is to be linked not to suffering loss, but rather to some other trigger, consider using other language, such as “covenants to pay” or “undertakes to pay”.
Finally, some kinds of liability can take a very long time (potentially years) to be finally determined and therefore crystallise. There is a risk that a buyer might be “locked out” of bringing a claim by any statutory or contractual limitation periods. Buyers should therefore ensure that they are entitled to notify a seller of a potential or contingent claim, and that any time limits for starting legal proceedings do not begin until the substance of the claim solidifies.

Court finds that individual was not a de facto director

The High Court has refused a “double derivative” claim by two beneficiaries of a trust against an alleged de facto director of a company, because that person had not actually assumed the role of director.

What happened?

Popely and Popely v Popely and others revolved around a company that operated a timeshare business. The company was set up by two brothers – John and Ronald. It was initially registered in the British Virgin Islands but ultimately migrated to the Caribbean island of Nevis (part of the Federation of St Kitts and Nevis).

All of the company’s shares were registered in the name of a corporate trustee, which held 30% of the shares on trust for members of the older brother’s family, and 70% on trust for members of the younger brother’s family.

In short, in due course the beneficiaries of the older brother’s trust alleged that the younger brother had misappropriated some of the assets of the business. They claimed that, although he had not been formally appointed, the younger brother had effectively assumed the responsibilities of a director of the company. This, they said, made him a de facto director who owed duties to the company, and the misappropriation of business assets was a breach of those duties.

They therefore launched a derivative claim against the younger brother for breach of duty as a director. A derivative claim allows a shareholder to bring a claim on behalf of a company against one of its directors for breach of duty. In this case, because the claimants were not shareholders, but rather beneficiaries under a trust, the claim was a “double derivative” claim.

As with a regular derivative claim, any damages payable or monies recovered would go to the company, not the persons bringing the claim (i.e. the beneficiaries). However, the beneficiaries would clearly benefit, as compensating the company would restore value to their 30% shareholding.

The court naturally had to decide whether the younger brother did in fact misappropriate assets. However, the decision is more interesting for the court’s analysis of whether the younger brother was indeed a de facto director.

This is an area of law that has long been unclear, particularly around the edges, where the concept of a “de facto director” begins to merge with that of a “shadow director” – a person in accordance with whose instructions the directors are accustomed to act.

What did the court say?

The judge felt that the young brother was not a de facto director. In giving his reasoning, he reflected on recent cases, before setting out some useful principles:

The concepts of de facto director and shadow director overlap. However, where an individual does some act in their capacity as a shadow director, they cannot also be doing that act in their capacity as a de facto director. (The opposite must presumably also be true…)
By the same token, if an individual validly did something in another capacity, they will not have done that act as a de facto director. In other words, the judge is suggesting that an employee or commercial agent is not at risk of becoming a de facto director.
Whether someone is a de facto director depends on the corporate governing structure of the company and whether the individual assumed a role as a director.
The court will assess this objectively, rather than looking at whether or not the individual believed they were a director.
Merely being involved in the management of a company, or exercising a degree of influence, will not make someone a de facto director (although it might make them a shadow director).

Effectively, the court refused to characterise the younger brother as a de facto director because of a lack of evidence. The beneficiaries had not explained the company’s corporate governance system to the court, nor had they provided any facts behind the alleged misappropriation itself.

All the beneficiaries had argued was that the younger brother had instructed and caused the company’s official director to make the allegedly inappropriate payments. At the most, the judge said, this would have made the younger brother a shadow director, not a de facto director.

What does this mean for me?

De facto and shadow directors share many of the responsibilities – and, hence, liabilities – of formal (or de jure) directors. For individuals who are not prepared to assume these duties, it is critical not to exert an undue level of influence or management over a company.

The judgment in this case helpfully confirms, however, that a person who is properly acting in some other capacity is at a much lesser risk (if any) of becoming a de facto director.

Where it’s clear that some individual will be managing some or all of a company’s affairs, it may be helpful to formalise this by appointing the individual in some recognised capacity, such as an employee, agent, contractor or representative. Any such arrangement should clearly define the individual’s authority and give them enough latitude to operate freely and flexibly.

Although this may not prevent a person from being a shadow director, it should at least avoid arguments that the person has effectively assumed the office of director.

London Stock Exchange updates AIM Rules

The London Stock Exchange has announced that it is publishing updated versions of its AIM rulebooks to reflect the new EU Prospectus Regulation.

The changes to the rules will take effect on 21 July 2019, when the Prospectus Regulation will come into effect in the UK. The Exchange will publish updated rules and guidance notes on that date. In the meantime, the Exchange has published mark-ups of its AIM Rules for Companies, Note for Investing Companies and Note for Mining, Oil and Gas Companies showing the forthcoming changes.

The changes are principally technical and ensure that the content requirements for an AIM applicant’s admission document that currently derive from the Prospectus Directive will align properly with the new EU Prospectus Regulation.

Under current UK legislation, if the UK leaves the European Union without a withdrawal (or implementation) agreement, the EU Prospectus Regulation will continue to form part of UK law, with certain amendments.

Other items

Government moots proposals for prompt payments. The Government has published a response to its call for evidence last year on how to improve prompt payment of invoices. The response contains a number of concrete proposals. They include a commitment to implement changes announced by the Chancellor this Spring to require audit committees of large companies to report on their companies’ payment practices in the annual report.
EU lowers threshold for SME growth markets. The European Union has published a new regulation lowering the criteria for a debt issuer to qualify as a small or medium enterprise (SME) (and hence access the new and more relaxed SME growth markets regime). Whereas previously an issuer needed to satisfy two out of three criteria (based on headcount, balance sheet total and turnover) to qualify, from October 2019 they will qualify as SMEs provided they have issued no more than €50 million of debt over the previous year.
Prospectus content requirements published. The European Union has published the final regulation setting out the required format and contents of a prospectus for listing equity securities. In particular, the regulation contains 29 annexes listing the information to be included in the different parts of a prospectus or in an EU growth prospectus. In the UK, the Financial Conduct Authority is proposing to incorporate these requirements by reference into its Prospectus Rules. The new prospectus regime comes into effect in the UK on 21 July 2019.
Technical standards for prospectuses published. The European Union has published the final regulation setting out certain technical standards for prospectuses published from 21 July 2019 under the EU Prospectus Regulation. In particular, the regulation sets out the key financial information to be included in the summary of the prospectus. Alongside a balance sheet and cash-flow statement, an equity issuer will need to state total revenue, operating and net profit and profit margins, year-on-year revenue growth, and earnings per share. The regulation also states how prospectuses will need to be advertised, and when an issuer will need to publish supplements to its prospectus.
EU consults on short-termism. The European Securities and Markets Authority (ESMA) is consulting on potential undue short-termism stemming from the financial markets that may be affecting corporations. ESMA is concerned that short-termism may be leading companies to underinvest in long-term value drivers, such as innovation and human capital, and overlook