Corporate Law Update
- A director of a listed company breached his fiduciary duties when he engaged in private discussions with shareholders and “briefed against the board”
- The first-tier tax tribunal decides that cumulative preference shares were “ordinary share capital” and so counted towards the qualifying holding for entrepreneur’s relief
- Other items of interest
The High Court has found that a director of a publicly listed company breached his duties when he “briefed against the board”, including by holding unauthorised discussions with shareholders and communicating disparaging views to shareholders and employees.
The court also considered whether other directors of the company had breached their duties when they took certain actions in response.
The judgment is almost 1,000 paragraphs long, fact-dense and covers claims for breach of fiduciary duty, breach of employment agreement and “unlawful means conspiracy”. The summary below covers only the claims for breach of fiduciary duty.
Stobart Group Limited v Tinkler concerned an infrastructure support services company. The company was incorporated in Guernsey but listed on the London Stock Exchange and included within the FTSE 250 index.
In July 2017, the company’s chief executive officer – Mr Tinkler – stepped down from his role of ten years. At the time, it was agreed that he would devote 50% of his time to the company as an executive director, and 50% to an investment vehicle he and another had set up.
However, relations between Mr Tinkler and the company’s non-executive chair – Mr Ferguson – deteriorated after Mr Tinkler raised concerns about the company’s management and strategy and his own remuneration for past performance.
Initially, Mr Tinkler told Mr Ferguson that he expected appropriate remuneration for his historic contribution, or he would resign. The two agreed that Mr Tinkler would speak privately to the company’s four main shareholders to gauge their views on him potentially stepping down.
However, on engaging with representatives of those shareholders, Mr Tinkler did not raise his potential resignation. Instead, he aired his grievances with the company’s board. Buoyed by support from some of those shareholders, he then pursued a plan that would see him replace Mr Ferguson as chair.
This culminated in Mr Tinkler taking a number of steps:
- Sharing a confidential budget with a friend and co-investor (a Mr Day) with a view to destabilising the board.
- Writing an open letter to the company’s shareholders, penned in his capacity as an executive director, publicly criticising the board without first raising his concerns with his fellow directors.
- Forwarding a copy of the letter to the company’s employees.
- Working with another individual to organise a petition by 80% of the company’s second-tier management (the “employee petition”), asking Mr Ferguson to step down.
- Requisitioning a resolution at the company’s upcoming AGM to remove Mr Ferguson as chair.
In response, the board took various steps, which need to be seen in the context of the upcoming AGM at which all of the directors were standing for re-election. These included:
- Establishing a committee to consider how to respond to Mr Tinkler’s actions.
- Issuing an RNS announcement to provide context to the on-going dispute, setting out specific concerns about Mr Tinkler’s behaviour in terms Mr Tinkler claimed were inflammatory.
- Transferring two large packets of shares from treasury into an employee benefit trust (EBT). This was done ostensibly to satisfy long-term incentive plan (LTIP) awards. However, in reality it was designed in part to allow those shares to be voted in favour of Mr Ferguson’s re-election.
- Acting through the committee, using a power in the company’s articles to remove Mr Tinkler as a director before the AGM. The board consequently removed the resolution to re-elect Mr Tinkler from the AGM agenda on the basis it would have no effect if passed.
The AGM took place. Mr Ferguson was re-elected as a director with 51.21% of votes in favour.
With the resolution for his re-election no longer on the agenda, Mr Tinkler moved a new resolution at the meeting for his election as a director. That resolution passed with 51.44% in favour and Mr Tinkler was (re-)elected.
The day after the AGM, the committee again removed Mr Tinkler as a director using the same power.
The legal context
The company brought claims against Mr Tinkler for breach of fiduciary duty, breach of his employment agreement and “unlawful means conspiracy”. This summary concentrates only on the alleged breaches of fiduciary duty. Mr Tinkler, in turn, brought counterclaims against the other directors for breach of fiduciary duty and sought declarations setting certain of the board’s actions aside.
It is worth noting that, as the company was incorporated in Guernsey, the relevant fiduciary duties were those at Guernsey common law. The court acknowledged these were the same as the fiduciary duties that a director of an English company owed before the Companies Act 2006 came into effect. The three duties central to this case were:
- to use powers conferred on a director only for a proper purpose (equivalent to section 171(b), Companies Act 2006);
- to act in good faith in the company’s best interests (equivalent to section 172, Companies Act 2006), which the court also described as the “duty of loyalty”; and
- to exercise independent judgment (equivalent to section 173, Companies Act 2006).
The judgment is slightly confusing, as the judge tended to lump the second and third duties, and sometimes the first, into an overriding “duty of loyalty” to the company. The company also raised claims under a duty to avoid a conflict of interest, which the court also subsumed into its assessment of this “duty of loyalty”.
What did the parties claim?
The company claimed that Mr Tinkler had breached his fiduciary duties by airing his grievances with the board in private conversations with shareholders, sharing confidential information with Mr Day, sending his letter to shareholders and employees, and orchestrating the employee petition.
Mr Tinkler claimed that the directors had used their powers for improper purposes when they established the committee to consider Mr Tinkler’s future, removed him as a director both before and after the AGM, and caused the shares in treasury to be transferred to the EBT. He said that his removal after the AGM was particularly improper, given that the company’s shareholders had only just resolved to re-elect him.
Finally, he claimed that the directors had breached their duty to act in the company’s best interests when they issued the supplementary RNS announcement.
What did the court say about the company’s claims?
The court agreed with the company on all of its claims. In particular, the judge said the following:
- Mr Tinkler should not have aired his concerns to selected shareholders without raising them first with the board. Alternatively, if it was the shareholders that had prompted discussion of Mr Tinkler’s views, he should have curtailed the conversations instead of offering his own dissenting views. Either way, he was “briefing against the board” and in breach of his duty of loyalty.
- By divulging the confidential budget to Mr Day, he again breached his duty of loyalty. The judge rejected Mr Tinkler’s argument that he was entitled to disclose the information in order to pursue a business opportunity for the company. Rather, he had been pursuing his own agenda.
- His letter to shareholders was “disgraceful” and "seriously misleading". It accused the board of attempting to remove him, when it was he who had precipitated discussions over his departure, and was a further example of “briefing against the board”. He should not have written it in his capacity as director. Sending a copy to employees was a "further wholly unjustified step". Both actions put him in breach of his duty of loyalty and his duty to exercise independent judgment.
- Orchestrating the employee petition was also a breach of Mr Tinkler’s duty of loyalty.
Much of the judge’s decision centres on the concept of “briefing against the board” and the duty to exercise independent judgment. His comments included the following:
- The duty to exercise independent judgment does not allow a director to "go off and do his own thing, independently of the board, in relation to matters that fall within the sphere of management of the company's business". Any discussions of those matters should be “in the presence of the rest of the board or with the prior approval of the board".
- A director should therefore raise their position on such matters at board level, either as part of the majority or as a dissenting voice. They are not entitled to speak or act as a director without observing their responsibilities to that collective decision-making body.
- However, a dissenting director could ventilate their views at a general meeting, because then they would be giving their views in open forum to all shareholders who attend the meeting.
- A board is unlikely to authorise discussions with some but not all shareholders, either at all or without agreeing the terms of the message first. It is “difficult to see a case for discriminating between shareholders”, and so the board should normally present its views in a general meeting or in a circular to all shareholders.
- A director who disagrees with the majority of the board does not have to resign, even if the decision is a “momentous one”. The director discharges their duty merely by raising an objection.
- Directors must not "pick off" individual shareholders in advance of a general meeting by making private approaches and airing their own views. This creates a risk that a director will breach their duties. This applies whether or not the director has aired their grievance to the board, but even more so if they try to "short-circuit the board” by taking issues direct to shareholders.
What did the court say about Mr Tinkler’s claims?
Generally, the court disagreed with Mr Tinkler. The judge said the board had acted in good faith and used its powers properly when establishing the committee and each time they removed Mr Tinkler from office. They had taken legal advice, and their decisions were all the more justified given Mr Tinkler’s serious breaches of duty.
In particular, in relation to the second time the committee removed Mr Tinkler, the judge said it was irrelevant that Mr Tinkler had been very recently re-elected. The directors owed their duties to the company, and “not to the 51.44% of shareholders who had voted in favour of Mr Tinkler's election".
The judge did say that the supplementary RNS announcement was “unwise” and “inappropriate”. But publishing it did not amount to a breach of duty, because the directors believed it was in the company’s best interests, and the court could not say that no reasonable director would have agreed to it.
However, the court did agree in part with Mr Tinkler in relation to the treasury share transfers. The purpose of the first transfer of shares was to satisfy LTIP awards, and this was reasonable and proper. But the primary purpose of the second transfer was to “manipulate the outcome” of the AGM. This was not a proper use of the directors’ powers and amounted to a breach of duty.
The transfer was voidable (not void from the outset), meaning the court had discretion over whether to unwind it and to declare Mr Ferguson’s re-election invalid. However, given that the trustee of the EBT had given good receipt for the treasury shares and had deliberated properly over how to exercise its voting rights, the court was not prepared to do this.
What does this mean for me?
Although the judgment revolves around Guernsey law duties, it will be highly persuasive in English law. The decision provides some practical points for directors who are unhappy with their board’s management style:
- A dissenting director should raise their concerns with the board before taking any further action. Failing to consult with fellow directors in the first instance brings a serious risk of breaching their duties to promote the company’s success and to exercise independent judgment.
- A director who is unable to persuade the board of their view should consider carefully whether or not to air their views publicly. Open criticism risks undermining the board’s authority and breaking with collective responsibility, which is not consistent with a director’s duties.
- If a director feels it absolutely necessary to speak out publicly, they should do so in a forum which is open to all shareholders. They should not corral support through private discussions with shareholders. Selective communication of this kind is likely to amount to a breach of duty.
- The director should make it clear they are communicating as a shareholder, rather than in their role as a director. Although this will not allow the director to “shed” their duty of loyalty, it will establish context for the communication.
- Even then, any communication with shareholders should use moderate language based on verifiable data, facts and figures, rather than rely solely on the director’s personal opinions.
- Ultimately, if a director cannot find a suitable way to communicate their concerns, they should consider resigning. On leaving office, their duties will not apply going forward and they will be free to voice their grievances.
The decision also provides lessons for boards trying to deal with a wayward director:
- If removing the director from office, make sure there are grounds to justify this. Forcing a director out of office without justification will put the company in breach of the director’s service contract and may be an improper use of the directors’ powers.
- Consider carefully any external announcements that refer to the director. The board may justifiably feel they are under an obligation to explain circumstances in the run-up to a general meeting so that shareholders have the information they need to exercise their voting rights. But any communications should be moderate in tone and based on evidence.
- Avoid actions that are likely to manipulate the outcome of votes at a general meeting. The directors are of course free (and, indeed, may be duty-bound) to give their view on a particular resolution, but it is not appropriate to re-jig shareholdings before the meeting to gain support.
The court has said that cumulative preference shares were “ordinary share capital” for the purposes of entrepreneurs’ relief (ER).
What is entrepreneurs’ relief?
ER is a relief from capital gains tax (CGT) which is available to individuals when (among other things) they sell shares in a company. Broadly, provided certain conditions are satisfied, the individual will pay a flat rate of 10% on any gain they make on the shares of a business (up to a lifetime limit of £10 million), rather than the usual 20% rate. ER often features on venture capital and certain kinds of private equity investments.
One of the conditions is that the individual has held shares comprising at least 5% of the company’s “ordinary share capital” for at least two years before selling them. (The holding period was increased from one year to two years from 6 April 2019.)
For this purpose, a company’s ordinary share capital is all of its issued share capital other than capital which gives its holders “a fixed right to a dividend at a fixed rate but no other right to share in the company's profits”. Normally, this will exclude most kinds of preference share, which carry a fixed dividend (calculated as a percentage of the subscription price) and no other right to receive profits.
What happened here?
In Warshaw v HMRC, an individual claimed ER on the sale of shares he held in a company. Those shares included “cumulative preference shares”. The company’s constitution described these shares simply as “preference shares” and stated that they gave their holder the right to a “preference dividend”.
The preference dividend was initially calculated as 10% of the price paid for the preference shares. Preference dividends were to accrue and be paid annually. If a preference dividend were not paid in a particular year, it would be rolled over into the following year. The following year’s dividend would be then calculated as 10% of the subscription price plus the amount of all accrued but unpaid preference dividends. In other words, any unpaid preference dividends were to be compounded annually.
The preference shares carried no other right to participate in the company’s profits.
If the preference shares were “ordinary share capital”, then, when added to his other shareholdings, the individual would have held 5.777% of the company’s “ordinary share capital” and so qualified for ER. However, if they were not, he would have held only 3.5% and so would not have qualified.
HMRC said the preference shares were not “ordinary share capital” and challenged the individual’s claim for ER.
What did the court say?
The matter came before the First-tier Tax Tribunal. The key question for the tribunal was whether the preference shares provided dividends at a “fixed rate”.
HMRC argued that the dividend rate was fixed at 10%, even if the underlying number to which that rate applied varied (depending on whether dividends were paid). The individual argued that, because the underlying number varied, the dividends were not in fact paid at a fixed rate.
It is worth noting that HMRC's position in this case was consistent with its published guidance, which states that cumulative fixed-rate preference shares that compound year on year are not "ordinary share capital" (and so are not taken into account when calculating whether an individual qualifies for ER).
However, the judge decided that the preference dividend was not payable at a fixed rate. He said that, for this to be the case, “both the percentage element and the amount to which it is applied to identify the rate of the dividend” needed to be fixed. In this case, the second element was not fixed, as it varied from year to year depending on whether previous preference dividends had been paid.
As a result, the shares were ordinary share capital and the individual was entitled to ER.
What does this mean for me?
In this case the court's decision was helpful for the individuals claiming ER. However, in many cases the opposite may be true.
For example, a company may have a financial sponsor which has invested using fixed-rate preference shares that compound over time. If the investor's shares count as equity (and not debt, even though economically this is their real function), this may effectively dilute individuals’ holdings of ordinary shares in the company below the required 5% and so impact on their ability to claim ER.
We will need to wait to see whether HMRC decides to appeal to the Upper Tax Tribunal. In the meantime, it is worth remembering that this case is only a first-tier decision and is contrary to HMRC's published guidance. The decision therefore creates uncertainty as to how to apply the ER rules where the company has issued fixed-rate compounding preference shares.
Moreover, the definition of "ordinary share capital" is used widely throughout the UK tax code (and not just for ER). The decision may therefore have a wider impact and lead to greater uncertainty in practice than the court anticipated.
- Takeovers. The High Court has sanctioned a scheme of arrangement for the takeover of a company, even though the company had inadvertently omitted to send notice of the court-convened shareholding meeting to five shareholders who had acquired shares in the company on the day before the record date. The court was satisfied that the omission did not have a serious impact on the scheme. (Re Rhythmone plc)
- Growth markets. NEX Exchange is consulting on changes to the Rules for Issuers on its Growth Market. It has produced a mark-up showing the proposed changes, which reflect the upcoming EU Growth Market Prospectus regime. The new rules would largely adopt the format under that regime and would not differ substantially from current requirements. NEX highlights one key change: prospectuses would not need to include a working capital statement. This is because, under the EU regime, a working capital statement is required only if the issuer’s market capitalisation is above €200m. However, the NEX Growth Market is intended to cater for issuers below this threshold. NEX has requested comments by 31 May 2019.
- Financial reporting. The Financial Reporting Council (FRC) is consulting on changes to its Standards for Investment Reporting (SIRs). The SIRs set requirements and provide guidance for reporting accountants carrying out reporting engagements on UK investment circulars. The changes are designed to reflect significant changes in the UK regulatory landscape and in accounting, auditing and assurance standards since they were last refreshed. The FRC has requested comments by 26 July 2019.