Corporate Law Update
- The High Court considers whether the directors of a company breached their duties by failing to include potentially material information in a shareholder circular
- A few other items
The High Court has rejected a claim by a group of shareholders of a company against its directors for improperly recommending a reverse takeover and failing to disclose material information.
Last week we looked at the claim that the directors had failed to exercise reasonable care and skill when deciding whether to recommend the takeover. This week we look at whether they breached their duties to shareholders by including misleading statements in and omitting material information from the shareholder circular relating to the proposal takeover.
Sharp v Blank concerned the 2009 takeover of HBOS plc by Lloyds TSB Group plc to create what would become the Lloyds Banking Group. For a detailed summary of the background, see our Corporate Law Update from last week.
The takeover completed in January 2009. Some years later, a group of 5,803 current and former shareholders of Lloyds (the “claimants”) launched a claim against most of the executive directors of Lloyds at the time of the takeover, alleging that the takeover had overvalued HBOS, disproportionately diluting their shareholdings in Lloyds and bringing their value down.
Among other things, they argued that Lloyds’ directors at the time were under a duty to ensure that information provided to shareholders in connection with the takeover was accurate and did not omit anything material, but had provided inaccurate statements and failed to provide key information.
They said these errors artificially inflated HBOS’ share price. Had the directors included the necessary information in the circular, HBOS’ real value would have been clear. Shareholders would have rejected the takeover and the claimants would not have been affected.
What was the substance of the disclosure claim?
The claimants alleged the following:
- when giving responses during presentations to analysts and journalists, the defendants were under a duty to ensure the comments they made were accurate and did not omit material information. But they had failed to provide complete and correct details of how much due diligence Lloyds had conducted on HBOS and of HBOS’ liquidity position, capital strength and value; and
- separately, they were under a duty to shareholders to ensure that information contained in the shareholder circular was accurate and did not omit anything material. Because the circular was published for a general meeting, they were also under a duty to ensure it contained enough information to allow shareholders to decide how to exercise their voting rights.
But the circular contained inaccurate statements and omitted information. It did not disclose emergency funding provided to HBOS by Lloyds and the Bank of England, it did not explain that the level of HBOS’ losses would require the combined group to raise further capital in 2009, and it did not disclose certain internally generated impairment figures relating to HBOS’ assets.
Were the directors liable for comments at the presentations?
No. The judge said the directors had not assumed any duty of care to shareholders. Their comments were made to journalists and analysts, not shareholders. There was no evidence that shareholders had relied on their comments.
In addition, the presentations took place around the time Lloyds published regulatory announcements and the circular. Those announcements had urged shareholders to read the circular before taking action, and the circular contained an “elaboration of the relevant risk factors”. The judge did not see how comments at the presentations could displace the wording of the announcements or circular.
Were the directors under a duty in relation to the circular?
Yes. The circular contained a statement that the directors had taken care to ensure the information in it was accurate and did not omit anything relevant. This created a duty of care towards shareholders.
They were also under a duty to include sufficient information in the circular to allow the shareholders to make an informed decision. This did not require them to disclose all information that had affected their view of the deal. Rather, they needed to exercise judgment about the level of information required to create a “commercially informative document that aids comprehension”.
As a result, if they had in fact omitted material information, they could be liable to compensate the claimants for any loss suffered, either because they had made “negligent misstatements” or because they had not disclosed sufficient information to inform the shareholders’ voting decisions.
Although, strictly speaking, the two claims have a very different basis in law, the judge effectively dealt with them both by applying the traditional test for negligent misstatement. This required the claimants to show the following:
- information or statements in the circular were factually inaccurate (including by omitting material information), and the directors knew or should have known this;
- the directors knew or should have known that the claimants would rely on that information; and
- the claimants in fact relied on the inaccurate information and suffered loss as a result.
Did the directors breach those duties?
In the end, the key question was whether it was reasonable for the directors to have omitted the information which the claimants argued should have been included in the circular.
The claimants highlighted seven instances of alleged non-disclosure. In five cases, the court said the directors had acted reasonably and the judge refused to award compensation. The directors had acted reasonably, even if they hadn’t correctly anticipated the economic effect of the acquisition.
The judge made several points that are useful to note:
- in deciding what to include, the directors had to take a view on the likely economic effects of the takeover. Even if they had guessed incorrectly, they had formed their view on the basis of honestly held beliefs and in line with what many market analysts were saying. In each case, the decision they made was one a reasonable director could have reached;
- they had taken legal and financial advice on the circular, which had not revealed any concerns about its contents. Although they were not required to follow that advice, the judge said that a reasonable director could certainly take comfort from it;
- the circular had been put through a thorough verification process to ensure it complied with legal requirements, and it had been challenged by accountants. The directors were entitled to trust their view and were not required to “deep-drill” into their accounting exercise; and
- the circular had been approved by the UK Listing Authority, which had been aware of the matters that were missing from the circular and had not raised any issues.
However, the judge was satisfied that the directors had breached their duty by failing to include details of the emergency facilities provided to HBOS by Lloyds and the Bank of England.
In these cases, the board had failed to provide sufficient information to shareholders. Both facilities were matters that shareholders might reasonably need to know about to make an informed decision on how to vote, particularly because each facility was, in its own way, unusual.
A “fair, candid and reasonable account” of the proposed acquisition would have disclosed that HBOS was dependent on the facilities. The circular did not need to spell out the terms of the facilities, but it should at least have referred to them. However, there was no evidence the board had actually considered whether to mention the facilities in the circular.
In addition, by failing to disclose the existence of the facilities, the directors had breached their duty of care to shareholders and made a negligent misstatement. They had not taken all reasonable care to ensure the circular did not omit anything that was likely to affect the information in it.
Were the directors liable?
Even though the directors had breached their duties, the judge said that this breach did not actually cause any loss. In his view, the directors would still have recommended the transaction to Lloyds’ shareholders, even if the facilities had been disclosed in the circular.
In an interesting counterfactual analysis, the judge conjectured that disclosing the two facilities would have had a minimal effect on HBOS’ share price: a likely decline of “around 10-15%”, which he described as “neutral”. This would not have caused Lloyds’ directors to withdraw their recommendation or the takeover to fall through, because HBOS remained of strategic value to Lloyds.
There was also no evidence that shareholders would have voted differently if the facilities had been disclosed. At the meeting, 4% of shareholders by value had opposed the takeover. The claimants managed to show that a further 0.55% by value would have opposed it, but that still left a further 45.5% to explain. There was ample evidence that shareholders would likely have supported the directors’ recommendation. The claimants’ case to the contrary was built around unsubstantiated extrapolation.
In a final, decisive blow, the judge said that the law did not allow a “dissentient shareholder” who is bound by the vote at a general meeting to seek compensation on the basis that he has “lost the chance that the meeting might have reached a different view”.
What does this mean for me?
We have tried to summarise over these last two weeks a case which was multi-faceted and complex and a judgment that was long, detailed and fact-heavy. We could not cover every element of it, but we hope to have drawn out the key points of interest.
This second part contains some useful tips for company directors:
- always fully test whether circulars contain all potentially relevant information. If unsure whether a matter is material, err on the side of caution and include an appropriate level of detail;
- properly engage with your professional advisers on what information to include in a prospectus. Although this will not create a safe harbour, it will demonstrate that the directors have taken steps to ensure they have discharged their duty;
- give your professional advisers all potentially relevant information. In this case, Lloyds’ advisers were not aware of the Bank of England facility, which influenced the judge’s decision; and
- vet your circular by conducting a rigorous verification exercise.
One final thing. The Lloyds circular was published in 2008, before the current regime in section 90A of the Financial Services and Markets Act 2000 was introduced. That regime imposes liability on publicly traded companies in certain circumstances for publishing misleading or incomplete information.
It would be interesting to know whether, were the same thing to happen again today, the judge would have found Lloyds to be liable under section 90A. We strongly suspect not, as the crux of the judgment is that the directors acted neither dishonestly nor recklessly in publishing the circular.
- Capital markets. The European Securities and Markets Authority (ESMA) has published an updated summary of the offer threshold in each European Economic Area (EEA) territory below which an issuer does not need to publish a prospectus to offer securities to the public. The summary incorporates changes for nine EEA countries, and adds information for Liechtenstein.
- Heads of terms. The Court of Appeal has held that it was not possible for parts of a document to be “subject to contract” (and, so, not legally binding) but for other parts to create binding legal obligations. In Farrar v Rylatt, an individual and a company claimed they were entitled to profits under a profit-share arrangement contained in heads of terms dealing with the sale of some properties. The entire heads were marked subject to contract, and other parts of them were subsequently formalised as contracts, but the profit-share arrangement was not. The court refused to find that the profit-share section of the heads was legally binding. The decision shows the importance of ensuring that all parts of a term sheet are properly incorporated in binding contractual documentation.