Corporate Law Update

• The court examines whether a buyer of shares was able to claim under locked box leakage provisions, under an indemnity for historic liabilities, and in misrepresentation
• Final legislation is published to implement the EU Prospectus Regulation into UK law
• The court sanctions a scheme of arrangement for a public takeover, even though the meeting notices were not sent to all shareholders
• The London Stock Exchange publicly censures an AIM company for failing include information in its AIM admission document 12 years ago
• The Hampton-Alexander Review reports on the latest progress towards its target for women on boards

Court interprets indemnity and leakage provisions in share sale agreement, and denies misrep claim

The High Court has considered three interesting issues in relation to a share sale: had “leakage” occurred, were certain claims covered by an indemnity in relation to historic liabilities, and did the seller make a misrepresentation to the buyer?

What happened?

Al-Hasawi v Nottingham Forest Football Club concerned the sale of Nottingham Forest F.C. (the Club) by Mr Fawaz Al-Hasawi to Mr Evangelos Marinakis in 2017. Readers may recall that we covered this sale in our previous Corporate Law Update when discussing whether the buyer had a potential claim in misrepresentation.

The High Court has now had to consider three separate claims by the buyer:

• Did the Club make certain payments amounting to “leakage”, which were not allowed under the “locked box” provisions in the share purchase agreement (SPA)?
• What liabilities were covered by an indemnity given by the seller?
• Did the buyer enter into the SPA on the basis of a mispresented trial balance?

We will look at each of the three issues in turn.

Was there “leakage”?

As often happens on share sale, the SPA included a so-called “locked box”. Under a locked box, the price for the company to be acquired is fixed by reference to a historic date (the “locked box date”). The target company is not permitted to pay any money (or transfer any other value) to the seller or any persons connected with the seller after the locked box date.

Any amounts paid after that date are termed “leakage”, and the seller must pay them back to the buyer. There are normally exceptions (known as “permitted leakage”) for certain routine items.

In this case, the Club made certain payments after the locked box date. These included payments to other football clubs for player training, legal fees in relation to disputes involving the Club, and payments to a soccer school.

The buyer said these payments amounted to leakage, because, although they were not paid to the seller or a connected person, they reduced the Club’s liabilities, and this in turn benefitted the seller. In other words, the buyer was asking the court to read the leakage provisions quite widely, so that they extended beyond merely payments to the seller or a connected person and also covered payments that had an indirect benefit for the seller or a connected person.

The court was not prepared to do this. The judge said that it was clear the payments had not been made to the seller or a connected person, and there was no basis for reading the clause in the way the buyer had suggested. Whether the seller had benefitted from the payments was “irrelevant”.

What about the liabilities?

The SPA also included a bespoke term requiring the seller to indemnify the buyer for all “Liabilities” as at the locked box date above a particular amount (£6.6m). The SPA defined “Liabilities” in some detail. In particular, it limited them to liabilities relating to matters “on or prior to the [locked box date] (and only to the extent such liabilities relate to such period)”.

The buyer tried to claim various amounts under the indemnity. In support of this, the buyer argued that the definition of “Liabilities” was intended to reflect the definition of “liabilities” in accounting standards (specifically, Financial Reporting Standard 102 (FRS 102)). This would mean that, provided the liabilities were recognised in the Club’s financial position on the locked box date, they would be caught.

In making this argument, the buyer referred to the case of Macquarie International Investments v Glencore UK, in which the court said that the phrase “material respect”, in the context of management accounts, had to be interpreted by reference to accounting standards.

In response, the seller argued that the term “Liabilities” had a more restricted meaning than in FRS 102 due to the words cited above. This would mean that some of the amounts claimed were not payable, because they related to a period after the locked box date and so were not covered by the indemnity.

The court agreed with the seller. The judge said that the definition of “Liabilities” was “bespoke” and worded differently from FRS 102. It would be “harder work” to say that they meant the same thing – the court would have to conclude that the words “(and only to the extent such liabilities relate to such period)” had no meaning, which it was not prepared to do.

Those words tallied with the parties’ commercial intention and with the locked box mechanism, which were that any benefits and liabilities that accrued after the locked box date were to be absorbed by the buyer, not the seller. They were not “surplusage” resulting from “zealousness” by the draftsmen.

Was there a misrepresentation?

Around three months before the parties signed the SPA, the seller uploaded a trial balance for the Club to the deal data room. The balance showed liabilities at the locked box date of just under £6.6m.

The buyer said that the trial balance was inaccurate. In particular, the buyer argued that the trial balance amounted to a false representation by the seller of the Club’s liabilities, and that the buyer had relied on that false representation when deciding whether to sign the SPA. As a result, the seller had made a misrepresentation and the buyer was entitled to compensation.

The court disagreed for various reasons, including that it did not think the representation was false. However, more interestingly, the judge said that the buyer had not relied on the representation when deciding whether to enter into the SPA. Rather, it had relied on it for a much more restricted purpose: to ascertain the figure £6.6m for the purpose of the indemnity described above and so provide a specific remedy where the amount of the Club’s liabilities was higher than anticipated.

What does this mean for me?

The court’s decision in all three respects is logical.

The buyer was asking the court to read the SPA – both the locked box provisions and the indemnity – in a much wider and more liberal way than it had been written. Unsurprisingly, the court was not prepared to do this. The judge followed the now-established approach of looking at both the literal wording of the SPA and the commercial context.

The case also illustrates how, where there is any doubt, a court will construe an indemnity against the person who is seeking to rely on it.

The judge’s decision to disallow the misrepresentation claim is also pragmatic. Allowing the buyer to claim for misrepresentation would have been illogical when the buyer was not covered under the indemnity.

The key take-away from the case for someone buying a business is to ensure that the sale agreement captures all payments for which the buyer is expecting to be reimbursed.

• If drafting indemnities of any kind, including a locked box and leakage mechanism, specify carefully what kinds of payment are covered (including by reference to the person being paid).
• If the parties want to define terms by reference to accounting standards, the SPA should specifically state this and refer to the relevant standards by name (e.g. “FRS 102”).
• If a buyer is relying on the accuracy of a particular document when agreeing to buy a business, it is worth recording this in the SPA. In most cases, any representation will be superseded by a contractual warranty, but acknowledging the reliance may help.

Legislation implementing the Prospectus Regulation is published

The Financial Services and Markets Act 2000 (Prospectus) Regulations 2019 have been published, along with an explanatory memorandum.

The purpose of the Regulations is to fully implement the new EU Prospectus Regulation into UK law. As an EU regulation, the Prospectus Regulation will apply automatically in the UK from 21 July 2019 without any action by the UK. However, certain powers under the Prospectus Regulation need to be specifically assigned as a matter of UK law. This is what the new Regulations will do.

In particular, the Regulations provide for the following.

• The Financial Conduct Authority (FCA) will be the “competent authority” in the UK responsible for enforcing and exercising powers under the Prospectus Regulation. In practice, this doesn’t represent any change from the current regime.
• It will be able to “suspend” its scrutiny of a prospectus, in effect pausing the approval process. It will be able to do this if it has already imposed a prohibition or restriction order on the applicant, or has decided to do so on the basis of the application to approve the prospectus. (Broadly speaking, the FCA can impose an order if it is concerned that a particular security or activity would raise investor protection concerns or threaten the orderly functioning of the markets.)
• It will also be able to restrict a person from making a public offer or from admitting securities to a regulated market in similar circumstances.
• It will be able to refuse to approve any prospectus submitted by someone who has repeatedly or seriously infringed any prospectus-related legislation. The refusal could last up to five years.
• It will also be able to suspend or restrict trading on a trading facility in similar circumstances. The FCA is currently able to restrict trading on regulated markets, but this new power will extend to multilateral trading facilities (such as AIM) and private securities exchanges.
• Certain organisations (essentially, financial services providers and certain investment exchanges, clearing houses and central securities depositaries) will need to put whistleblowing procedures in place to allow employees to report breaches of the Prospectus Regulation.

The Regulations also make changes to the Financial Services and Markets Act 2000, and consequential changes to other legislation, to align them with the Prospectus Regulation.

The changes will take effect on 21 July 2019.

Under current UK legislation, the majority of the Prospectus Regulation will continue to have effect in the UK following the UK’s withdrawal from the European Union. However, certain aspects, such as the ability to passport a prospectus from the UK into the EU, will no longer apply.

Prospectuses that have already been approved under the current regime will remain valid, and will not need to be adapted to comply with the new regime, until the end of their validity period or 21 July 2020 (whichever is earlier).

Court sanctions takeover despite defective notice of meeting

The High Court has sanctioned a scheme of arrangement for the takeover of a public company, even though not all of the target company’s shareholders were given notice of the shareholder meetings to approve the scheme.

What happened?

Re RhythmOne plc concerned the takeover of UK video advertising company RhythmOne by Israeli counterpart Taptica International. Both companies were traded on the AIM market of the London Stock Exchange at the time of the takeover.

In order to implement a scheme of arrangement, RhythmOne had to ask the court for permission to convene a meeting to seek shareholder approval. This is commonly called the “court meeting”. It is also common for a company to convene a separate general meeting of its shareholders to approve other, incidental matters, such as changes to its constitution. This is what RhythmOne did.

As is common for AIM companies, RhythmOne’s shares were held partly in uncertificated form in the CREST system, and partly in certificated form outside of CREST. In order to settle and record trades in the uncertificated shares, CREST kept a list of shareholders and RhythmOne’s registrar – Computershare – kept a “mirror” register. Each day at 6pm, CREST would inform Computershare of any changes to its register, and Computershare would update the “mirror” register.

RhythmOne adopted 6pm on Friday, 22 February 2019 as the “record time” for printing the notice of its shareholder meetings. The notice was sent to everyone on the “mirror” register at that time. However, unbeknownst to RhythmOne, the “mirror” register had not been updated to reflect certain trades that had taken place that day.

The result was that five shareholders, who together held 0.01% of RhythmOne’s shares, did not receive notice of either shareholder meeting.

In the end, the court meeting was held and the takeover was overwhelmingly approved. 8.2% of RhythmOne’s shareholders, holding 61% of its shares by value, attended. (This was higher than the usual attendance at RhythmOne’s AGMs.) 87% of the shareholders present, holding 97.7% by value of the shares voting at the meeting, voted in favour.

To finalise the takeover, the court had to sanction the scheme. In doing so, the judge had to consider whether failing to send notice of the court meeting to the five shareholders invalidated the takeover.

What did the court say?

The court sanctioned the scheme.

The judge said it was not clear whether RhythmOne had complied with the requirement set out in the court’s order to convene the court meeting. However, the court still had the power to waive any of the requirements in that order if it felt it was appropriate to do so.

In this case, the judge noted that the five shareholders held a minute percentage of RhythmOne’s shares, and that, even if every one of them had voted against the scheme, it would still have passed. The failure to send them notice had not therefore had a serious impact on the scheme, and it would not be right to go to the trouble of convening a further court meeting.

The judge was also satisfied that the general meeting had been convened validly for two reasons:

• The Uncertificated Securities Regulations 2001 state that a company is not liable if it relies on its own “mirror” register, provided it has a procedure in place to regularly reconcile that register with the CREST register. This was the case with RhythmOne.
  
  This seems a slightly stretched interpretation of the Regulations, which state that a company is not liable for (for example) failing to send notice of a meeting, but do not specifically state that the meeting will be valid even though notice has not been given.
• Perhaps more convincingly, RhythmOne’s articles stated (as is typical) that an “accidental omission to send notice of a meeting” would not invalidate the meeting. The judge felt that the failure to send notice to the five shareholders was an accidental omission.
  
  Although RhythmOne did not raise the point, it seems likely that the judge would have reached the same decision based on section 313 of the Companies Act 2006. Section 313 states that accidental failure to give someone notice of a general meeting will not invalidate the meeting, as was clearly the case here.

What does this mean for me?

This is obviously a sensible – and helpful – decision. Traded companies constantly have to grapple with the fact that their shareholder base can by dynamic. This case shows that, provided a company takes reasonable and sensible steps, it should be protected.

It is worth noting though, that the reason the court sanctioned RhythmOne’s scheme was that it was prepared to waive RhythmOne’s failure to comply with its order. That was clearly right in the circumstances. The failure was purely technical and inadvertent, and it would have been illogical to require a re-run of the meetings.

However, the court will always look at the facts in each case and, we suspect, would very likely have insisted on a re-run if the failure to give notice would have a meaningful effect on the outcome of the scheme vote. The court may also decline to wave a scheme through if the failure is reckless, and will certainly not do so if it is deliberate.

AIM censures company for incomplete admission document

The London Stock Exchange (the Exchange) has publicly censured a company for failing to disclose the former name of one of its directors in its admission document. A public censure is one of the strongest penalties the Exchange can issue for breach of its rules.

Rule 3 of the AIM Rules for Companies requires a company to produce an admission document when it applies to AIM. The admission document must contain the information set out in schedule 2 to the AIM Rules, which includes each director’s full name and “any previous names”.

The company applied to AIM in 2005. (At the time, the applicable standards were set out in the October 2004 version of the AIM Rules.) Its admission document did not contain a previous name used by one of its directors (which was, essentially, a different spelling of his name). The director had previously been indicted in the United States under that previous name. By failing to disclose this information in its admission document, the company had breached AIM Rule 3.

The company had also failed to disclose the director’s former name and the indictment to successive nominated advisers, despite being specifically asked for that information. As a result, the company had also breached AIM Rule 31.

The events in question took place 12 years earlier, when the company had a different board. The company’s current board and advisers had difficulties in identifying the issues and took swift action when they found out and co-operated fully with the Exchange. In view of that, the Exchange decided to waive the fine of £350,000 it had initially intended to impose.

The censure shows the difficulties that face the incoming directors of a company that is admitted to (or intends to apply for admission to) a securities exchange, and the degree of reliance directors place on each other. New directors to a company should ideally diligence the history of the company and its existing directors, although there will always be matters that are difficult or impossible to discover.

FTSE companies on course to hit targets for women on boards

The independent Government-backed Hampton-Alexander Review has announced the latest progress towards its goal of ensuring that 33% of FTSE 350 board positions are occupied by women by 2020. The Government has issued a similar announcement.

The Review notes that FTSE 100 companies are on track to hit the target. 32.1% of FTSE 100 board positions are currently held by women.

In the FTSE 250, 27.5% of board positions are now held by women, up from 24.9%. The Review says that, for the first time, FTSE 250 companies “could meet the 33% target” if they maintain their current progress.

The Hampton-Alexander Portal is now open for companies to submit their data on women in leadership for the 12 months ending on 30 June 2019.