Corporate Law Update

This week:

• The court clarifies the extent of detail directors must give when disclosing their interest in an arrangement with their company
• The BVCA has published a further report on the impact of the ongoing Covid-19 outbreak on the PE/VC industry
• The Investment Association writes to FTSE 350 boards in relation to the Covid-19 outbreak
• Institutional Shareholder Services (ISS) issues new policy guidance during the Covid-19 outbreak
• The PLSA has urged investors to scrutinise companies’ responses to the Covid-19 outbreak
• ICSA publishes an article outlining the background to disruption to AGMs

Covid-19 is affecting the way people conduct their business, retain their staff, engage with clients, comply with regulations and the list goes on. Read our thoughts on these issues and many others on our dedicated Covid-19 page.

Court clarifies extent of directors’ interest notification

The High Court has examined the level of detail which directors must provide when notifying their fellow directors of a transaction in which they are interested.

What happened?

Fairford Water Ski Club Ltd v Cohoon [2020] EWHC 290 (Comm) concerned a water skiing club. The club took the form of a private company limited by shares with a board of directors.

Two of the club’s directors also ran a water ski school from the club’s premises.

In short, the club alleged that the two directors had been misappropriating club funds and causing it to pay unapproved management fees. In response, the ski school claimed that it and the club had entered into a management agreement in 2007 under which the management fees were payable.

One of the central issues was whether the directors had declared their interest in the alleged management agreement to the club’s board.

Under section 317 of the Companies Act 1985 (which applied at the time), a director of a company was required to declare the “nature of their interest” in any transaction or arrangement with the company. From October 2008, that section was replaced by section 177 of the Companies Act 2006, which imposes a duty on a director to declare the “nature and extent” of an interest in a company transaction.

The club argued that, by failing to disclose the amount of the fee payable under the management agreement, the directors had failed to declare the “nature” of their interest in the arrangement.

It also argued that, by the same token, the directors had failed to comply with a requirement of the club’s articles of association that each director declare the “nature and extent” of any interest they had in a transaction or arrangement with the club.

As a result, the club argued, the management agreement was “voidable”, meaning that the club was entitled to reject it and walk away from it.

What did the court say?

The court agreed with the club.

In deciding how much detail needed to be disclosed, the judge noted that the standard of disclosure required was “of the precise nature of the interest” that the director has, and that directors must show that they have complied “in letter and spirit” with the disclosure requirement. (This stems from the court’s previous judgment in Re Neptune (Vehicle Washing) Ltd [1996] Ch 274.)

This was based on a more general principle that directors, as fiduciaries of a company, are under a duty to make “full disclosure of all facts material to the transaction” (Mothew v Bristol and West Building Society [1996] EWCA Civ 533).

As a result, it was incumbent on any interested directors to disclose the amount of the management fee allegedly payable by the club. Failing to do so would mean they had not properly declared the nature (or extent) of their interest in the arrangement.

As it happens, the court found that one of the two directors was not required to disclose his interest, as he had not become a director until the management agreement had allegedly been entered into. But the other director had failed to disclose his interest under the Companies Act and the club’s articles.

As it happened, the court found (for other reasons) that the management agreement was not voidable.

What does this mean for me?

The decision shows how important it is for directors to provide full and frank disclosure of any personal interests they have that (broadly) are (or may reasonably be regarded as being) relevant to the affairs of a company of which they are a director.

Although case law has established for some time now that directors must disclose their interests comprehensively, in practice it can be difficult to strike the balance between unhelpfully regurgitating reams of detail and simply setting out the bare basics.

However, the consequences of getting this balance wrong can be significant. A director who fails to declare their interest will be liable for breach of duty. Remedies against the director can range from divulging any profit made, paying equitable compensation or holding any misappropriated assets on trust. Ultimately, the company may be able to unwind the arrangement completely.

There are some factors that soften this. For example, a director does not need to declare an interest that cannot reasonably be regarded as giving rise to a conflict of interest, or if the board is already aware of the interest. And, even if the director is in breach, the court has the ability to grant the director relief if it judges it appropriate to do so, but this does not happen commonly.

Directors who are interested, or potentially interested, in an arrangement with their company should therefore take certain steps:

• Make sure the other directors are fully aware of the interest. This can be by declaring the interest at a board meeting or by sending a notice in writing.
• Declare the interest before the company enters into the arrangement. Informing the board after the fact will not satisfy the duty to disclose.
• Provide sufficient information on the interest. This can be difficult to judge, but directors should certainly disclose any direct or indirect benefit they stand to gain from an arrangement. Generally, it will be sensible to disclose any key or significant terms of the arrangement.
• The duty to disclose is based on the rule that directors (as fiduciaries) should not put themselves in a situation of conflict or benefit from their position. A good rule of thumb is therefore: what would I want to know about if I were the other directors? If unsure, err on the side of caution and disclose more, rather than less.
• Keep the board updated. Interests in transactions can shift over time. A director who was not previously interested might become so. Perhaps more obviously, the nature and extent of a director’s interest might change over time as the arrangement is adapted or amended. A director may need to make further declarations over time.

BVCA polls members on Government coronavirus initiatives

The British Private Equity and Venture Capital Association (BVCA) has conducted a further poll of its members on the impact of Covid-19 on the private equity and venture capital industry. The key points arising from the report are as follows:

• Finance for larger companies. Since the BVCA’s recommendation last week that the Government provide a new “working capital loan guarantee scheme”, the Government has announced a new Coronavirus Large Business Interruption Loan Scheme (CLBILS), which is open to businesses with a turnover of between £45 million and £500 million.
• Finance for SMEs. The BVCA is continuing to press for the turnover of PE/VC portfolio companies to be disaggregated when determining whether companies qualify for the Coronavirus Business Interruption Loan Scheme (CBILS).
• Early stage companies. The BVCA is also continuing to press for a proposed new bridge funding facility for VC-backed, early stage businesses.
• Valuation. A majority of respondents to the poll expect to significantly mark down their portfolio valuations, with an average mark-down of around 20%.
• Employees. Over 550 portfolio companies across the BVCA’s sample have taken the decision to furlough some or all of their staff. This represents, on average, an increase of five companies per portfolio since the BVCA’s previous poll. For further information generally on furloughing during the Covid-19 outbreak, see our colleagues’ briefing note.
• Ongoing trading. Respondents estimated that (on average) 83% of companies would be able to continue trading following a three-month lockdown, reducing to 61% after a six-month lockdown and 42% after a 12-month lockdown.
• Wrongful trading. Finally, the BVCA is continuing to support the Government’s proposal to suspend wrongful trading legislation. It also continues to ask for guidance for directors and for the Government to consider amending the legislation around directors’ duties. For further information generally on the Government’s proposed changes to insolvency law as a result of the Covid-19 outbreak, see our colleagues’ briefing note.

Also this week…

• IA writes to FTSE boards on Covid-19. The Investment Association (IA) has written a letter to the boards of FTSE 350 companies expressing the industry’s commitment to supporting British business during the Covid-19 outbreak. The letter covers the IA’s views on various matters, including engaging with shareholders, financial reporting, AGMs, dividends, executive remuneration and raising capital.
• ISS issues policy guidance during Covid-19 outbreak. Institutional Shareholder Services (ISS) has published new guidance to issuers in light of the Covid-19 pandemic. The guidance covers issues such as AGM postponements and virtual AGMs, changes to management and to director compensation, and share issuances and repurchases.
• PLSA urges scrutiny during Covid-19 outbreak. The Pensions and Lifetime Savings Association (PLSA) has published a statement reminding pension schemes to be watchful of how companies in which they have invested respond to the ongoing Covid-19 outbreak. In particular, it recommends that investors consider voting against directors who they believe have not behaved appropriately towards their workforce this AGM season.
• ICSA publishes commentary on AGMs. Peter Swabey, Policy and Research Director at ICSA: The Chartered Governance Institute, has published an article on disruption to AGMs during the Covid-19 pandemic. The article is a useful and accessible summary of events and ICSA guidance to date on the topic.