Corporate Law Update
- A company had validly paid a dividend even though its directors did not hold a board meeting to approve that payment
- The court implies a term into a share sale agreement entitling the seller to see a copy of an auditor’s report prepared for the target company
- A couple of other items of interest
Over the last two weeks, we have been looking at 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.
Last week we looked at whether certain errors and overvaluations in the accounts used to justify the distribution rendered the distribution invalid. The week before, we looked at whether those accounts had to be set out in a single document for the distribution to be valid.
This week we look at whether the fact that the directors did not approve the accounts at a board meeting rendered the distribution invalid.
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. He claimed that the distribution was not valid unless the company’s directors had approved it in a board meeting. His reasoning was as follows:
- Statute requires a distribution by a company to be determined by reference to items set out in accounts. (As we noted last week, the company used “interim accounts” for this purpose.) This process requires the directors to consider and approve the accounts in a board meeting.
- The company’s articles stated that its shareholders could not declare a distribution that exceeded “the amount recommended by the directors”. To declare a distribution, therefore, the shareholders needed a recommendation from the directors, and the directors had to decide on that recommendation in a board meeting.
According to the liquidator, the company’s directors never held a board meeting. They therefore never justified the distribution by reference to the interim accounts, nor did they recommend the amount of the distribution to the company’s shareholders.
What did the court say?
The court disagreed with the liquidator on both counts. In particular, the judge noted the following:
- The Companies Act states that whether a company can make a distribution “is determined by reference to [certain items in] the relevant accounts”. However, this requirement is “passive”. It does not require directors to “actively reach a determination as to the amount of realisable profits”.
It is clearly important for directors “actively to consider whether the company has sufficient distributable reserves, or to ensure that there are accounts that comply with” the legislation. If they do not, they are likely to incur personal liability. But they are not required to hold a formal board meeting to approve the accounts.
- In any case, the court was satisfied that a board meeting had taken place. There were signed minutes of the meeting, which served as evidence that there had been a board meeting.
- Even if no meeting had taken place, the judge was happy that all of the company’s directors had approved the distribution. As a matter of law, directors can take a decision without holding a board meeting, provided they all concur with or informally acquiesce in the decision. In this case, they had done exactly that.
- Even if the shareholders had needed a recommendation from the directors to declare the dividend, this was a requirement of the company’s articles and so one which the company’s shareholders could waive under the “Duomatic principle”. (The Duomatic principle states that, where all of a company’s shareholders give their informal and unqualified consent to a decision that should be taken in general meeting, the decision is effective as if it had been taken in general meeting. The company can effectively ignore any failures to comply with any procedures set out in legislation or its articles, although there are some important exceptions to this rule.)
In this case, the company’s sole shareholder (its holding company) had signed a written resolution approving the dividend and so waived any need for a recommendation from the directors.
What does this mean for me?
Although the facts of this case were quite unusual, the court’s decision is helpful for companies, as it alleviates the concern that a dividend paid without holding a formal board meeting may be invalid.
However, when approving a dividend (whether paying an interim dividend or recommending a final dividend to shareholders), it is always best for a company’s directors to hold a formal board meeting to reach their decision. A board meeting is the best means for the company’s board to:
- table, consider and discuss the accounts that are being used to justify the dividend;
- consider any events that have occurred since the date of those accounts and which might have affected the company’s distributable profits;
- agree that paying the dividend is consistent with the directors’ duties to promote the company’s success for the benefit of its shareholders; and
- consider whether paying the dividend is likely to have any effect on the company’s creditors.
The High Court has held that the sellers of shares in a company were entitled, under an implied term of the sale agreement, to see a copy of a report produced for the target company by its auditor.
Zedra Trust Company (Jersey) Ltd v Hut Group Ltd concerned the sale of shares in a private limited company. The share sale agreement (SPA) contained a mechanism for identifying whether there had been any overprovisions for tax in the company’s accounts. Under that mechanism:
- The sellers could require the buyer to commission a report by the target’s auditor to determine whether there had been any overprovisions.
- If the auditor decided there had been an overprovision, the sellers would receive credit for that overprovision and perhaps even a further payment from the buyer.
- After the auditor gave its decision, either the sellers or the buyer could ask the auditor to “review” that decision and to take into account anything which had come to light in the meantime.
However, the SPA did not specifically give the sellers a right to see the auditor’s report.
In the event, the auditor was asked to make a decision and did so. The auditor provided its report to the buyer. The buyer informed the sellers of the auditor’s decision. It provided the sellers with the first 1½ pages of the auditor’s report (which contained a background section and an executive summary), but not the complete report.
The sellers brought legal proceedings to obtain a full copy of the full auditor’s report. Among other things, they claimed that, even though there was no explicit right in the SPA for the sellers to be given a full copy of the report, the SPA contained an implied term to that effect. They said that they needed to see that report in order to decide whether to request a review of the auditor’s decision.
What did the court say?
The court agreed with the sellers.
There is a wealth of case law on implying terms into contracts. Broadly speaking, the court can imply a term into a contract (in effect, writing into the contract a term that does not appear in it) if either:
- the term is necessary for the contract to have “business efficacy”, and the contract would “lack commercial or practical coherence” without it (the so-called “business efficacy test”); or
- the term is so obvious to a theoretical inquiring bystander that it goes without saying that it must form part of the contract (the so-called “officious bystander test”).
Strictly speaking, these are separate and alternative tests, and only one of them needs to be satisfied to imply the term. However, the court noted here that “it will be a rare case where one is present without the other”. In this case, the court found both tests were satisfied. In particular, the judge said:
- It would be unusual if the SPA allowed the buyer, who had an interest adverse to the sellers’, to decide how much of the report to show the sellers, particularly given that the sellers were paying for the report. The more unusual an arrangement, the less obvious it would be to a bystander.
- The more unfairly the term would operate between the sellers and buyer, the more scope there was to imply further terms. However, the court would not imply further terms merely because a term is unfair, because parties in commercial dealings are free to agree unfair terms. (This is, of course, subject to any restrictions in law, such as under the Unfair Contract Terms Act 1977.)
- Finally, in order to engage effectively in the process of requesting a review, the sellers needed to know “the basis of the original determination”. For this, they needed to see the report. Implying a term to this effect was therefore necessary to make the contract work properly.
What does this mean for me?
This decision shows the flexibility the courts will exercise to make sure that a contract functions in a sensible (and arguably fair) way.
The trouble with implied terms is that it is difficult to know exactly what form they will take until a dispute arises and the court has considered the contract. It is therefore important when drafting any clause, but particularly a mechanism such as the one in this case, to consider all possible eventualities and set out in a sensible level of detail how the mechanism is to work in each case.
There are numerous things to think about when drafting an independent expert mechanism. The following are merely a few:
- Include a procedure for the parties to identify the expert and state any qualifications that expert must hold. Often parties state that the expert must be an independent chartered accountant, but it is equally possible to appoint the auditor to a relevant company.
- Set out what happens if the chosen expert declines to act. This might happen if the expert is conflicted or lacks the time or expertise to complete the task. Without a “back-up” option (even one as simple as repeating the selection process), the parties may be left in limbo.
- A common fall-back is to ask the President of the Institute of Chartered Accountants in England and Wales to nominate an expert, and the Institute now has a process for taking requests. However, parties should also consider other reputable bodies, particularly if they are based overseas, and check whether those bodies are able to nominate an expert.
- Specify what information each party is to be provided throughout the process. This includes at the beginning of the process when raising a dispute, right through to any right of challenge.
- Consider setting time limits for each party to raise a dispute or provide information, with a default position if a party doesn’t respond in time. For example, it would be common to state that a party who doesn’t dispute a decision by a stipulated deadline is deemed to accept that decision.
- Tech investment. Tech Nation has published statistics showing a significant increase in incoming investment from the US and Asia into UK tech companies. The figures show that US$6.7bn was invested in the first seven months of 2019, with more than half coming from the US and Asia. Significantly, UK tech has now overtaken the US for foreign investment per capita.
- Court refuses to sanction cross-border merger. The court has refused to sanction a cross-border merger (CBM) because the pre-merger certificate for one of the companies had been obtained too long ago. The UK courts can sanction a CBM only if each participating company has obtained a “pre-merger certificate” within the previous six months. In Re Trade Holding PL-UK Ltd, however, one of the companies had obtained its certificate from the Polish courts 12 months previously, and so the court initially refused to sanction the merger. It later allowed the CBM to proceed after a fresh pre-merger certificate was obtained.