Corporate Law Update

In this week’s update: the risks of registering a trust as a shareholder, the FCA clarifies the requirement to publish a prospectus on a scheme of arrangement with a mix and match facility and a few other items.

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.

The risks of registering a “trust” as a shareholder

The High Court has given permission to a trust that was registered as the shareholder of a company to bring a multiple derivative claim, conditional on the company’s register being rectified to show the true legal owner of the shares held in the trust.

However, the case shows the risks of failing to ensure that the correct legal owner is registered as the holder of a company’s shares.

What happened?

Boston Trust Company Ltd v Szerelmey Ltd [2020] EWHC 1352 (Ch) primarily concerned a so-called “multiple derivative claim” by a trust holding shares in the holding company of a group of companies.

The trust, which had been set up by one of the two founders of the business, wished to bring claims against the other founder and companies associated with him.

However, the alleged wrongdoing had been inflicted not on the trust, but on various operating companies within the group. It was therefore those companies that had the right to bring a claim, but they were controlled by the alleged wrongdoer, leaving the trust without a means to bring a claim.

The trust therefore tried to bring a derivative claim on behalf of the operating companies. Under a derivative claim, a shareholder of a company can bring a claim on behalf of the company in certain circumstances. Any damages are awarded to the company, not the shareholder. A derivative claim does not, therefore, provide a direct remedy to a shareholder, but it can provide indirect redress by restoring value to the company (and, so, to the shareholder’s shares).

When a shareholder brings a derivative claim on behalf of the company in which they hold shares, the claim is regulated by statute (specifically, the Companies Act 2006). However, a shareholder can also bring a derivative claim on behalf of a subsidiary of the company in which they hold shares. This kind of claim (which is the kind the trust was bringing in this case) is known as a “multiple derivative claim” and is regulated by common law.

In both cases, the court must decide whether to allow the derivative claim to proceed and has a degree of discretion in this regard.

What was the problem here?

Critically, the person bringing the derivative claim must be a member (in most cases, a shareholder) of the company. This presupposes that the member is a natural person (i.e. an individual) or a legal person (such as another company).

In this case, however, the person listed in the company’s register of members was a trust established in the Isle of Man. It was an unincorporated entity with no separate legal personality. As such, the trust was not capable in law of being a member of the company or hold shares.

The fact that a trust cannot be a member of a company is underscored by section 126 of the Companies Act 2006, which states that “no notice of any trust … shall be entered on the register of members of a company in England and Wales”. Instead, it is the trustees of the trust who should be registered as the legal owners of the shares in a company. Beneficial ownership of those shares is then apportioned under the terms of trust instrument.

This meant that the trust was unable to pursue the derivative claim. However, the court was prepared to grant the trust permission to bring the claim conditionally on the company’s register of members being rectified to show the trustee, rather than the trust, as the shareholder. That would involve a separate set of legal proceedings to persuade the court to rectify that register.

What does this mean for me?

The important point to note from this case is the problems that can arise from failing to record the correct person in a company’s register of members.

As a general rule, a company limited by shares must not treat anyone as a shareholder other than the persons listed in its register of members. Article 23 of the Model Articles for Private Companies Limited by Shares (which forms part of many companies’ constitutions) states:

Except as required by law, no person is to be recognised by the company as holding any share upon any trust, and except as otherwise required by law or the articles, the company is not in any way to be bound by or recognise any interest in a share other than the holder’s absolute ownership of it and all the rights attaching to it.

Likewise, as noted above, section 126 prohibits a company from noting the existence of any trust in its register of members. This would include registering a trust as a shareholder of the company.

Although these provisions refer only to trusts, it is generally accepted that the same position applies to partnerships with no separate legal personality (such as English partnerships and limited partnerships) and to other “unincorporated associations” (such as sports clubs). This is because any property held by these entities must necessarily be held on trust by one or more of members for all of the membership.

As a result, a company should never register an unincorporated trust, partnership or association as a shareholder. There is no formal penalty for doing so, and indeed it is quite common to see unincorporated entities registered as shareholders. However, the company will not be able to deal with the unincorporated entity or treat anybody else as its shareholder. This can give rise to issues.

  • It will be unclear who is entitled to exercise any voting rights attaching to the shares “held” by the trust, partnership or association. This could leave the shares effectively disenfranchised.
  • Similarly, it may not be possible to exercise other rights attaching to the shares, such as to requisition a general meeting or to benefit from statutory rights of pre-emption.
  • There may be problems with paying dividends or other distributions, as there will be no legal person of record to whom the company should make payment.
  • It may be difficult to transfer the shares, as the person executing an instrument of transfer (the trustee) will not be the same as the “person” registered as the shareholder (the trust). Likewise, it may be difficult to grant security over the shares to secure loan finance.
  • As in this case, it may be difficult or impossible to pursue legal remedies against the company or (on behalf of the company) against its directors.

If an unincorporated trust, partnership or association has been registered as a member of a company, the register should be rectified. Strictly speaking, this should be done by applying to court under section 125 of the Companies Act 2006 for an order rectifying the register. The application will need to contain robust evidence showing who the true owner of the shares is in order to persuade the court to make the order.

There is a line of thinking that simple clerical or administrative errors in a company’s register of members can be corrected without applying to court, and there is some case law supporting this. However, this should not be done lightly and will be appropriate only in the most straightforward and uncontroversial of cases.

An amendment that involves changing the name of a shareholder will necessarily affect ownership of the shares, because the register of member is evidence of legal title. It will therefore almost always (if not always) be necessary to apply to court to make such a change. For this reason alone, it is important to ensure the register is written up properly from the outset.

Finally, it is worth noting that it is possible to register a trust or partnership as a member of a company if the trust or partnership has separate legal personality. For example, Scottish partnerships can hold shares in their own right, and certain jurisdictions offer incorporated trust and partnership structures.

FCA publishes Primary Market Bulletin 30, clarifies need for prospectus on a scheme of arrangement

The Financial Conduct Authority (FCA) has published Primary Market Bulletin Issue 30. The bulletin covers various items, including:

  • the importance of persons discharging managerial responsibilities (PDMRs) and the closely associated persons (PCAs) reporting dealings in their issuer’s securities;
  • the ability to issue an “exemption document” instead of a prospectus where securities are offered as part of a takeover offer;
  • small changes to the annexes specifying the contents of a prospectus as a result of recent EU legislation; and
  • updates to various technical notes to reflect the EU Prospectus Regulation.

Perhaps the most interesting item concerns the requirement to publish a prospectus where securities are offered on a takeover implemented by way of a scheme of arrangement.

Under the EU Prospectus Regulation, a prospectus must be published whenever a company offers its shares to the public (subject to certain exemptions). This includes where a bidder offers its own securities as the consideration on a takeover bid (a so-called “securities-exchange offer”) (although, as noted above, the bidder can elect to produce a shorter “exemption document” in these circumstances).

However, it is now more common to implement a takeover of a UK company by way of a statutory scheme of arrangement sanctioned by court order. This is an arrangement between the target company and its own shareholders under which those shareholders agree to transfer their shares in the target company to the bidder in exchange for the offer price.

In this case, the widely held view (which the FCA is not challenging) is that, because the takeover takes place by way of a scheme between the target company and its shareholders, there is technically no “offer” by the bidder and so the prospectus regime is not engaged.

This is recognised by Recital 22 to the EU Prospectus Regulation, which states that, where securities are allocated without an element of individual choice on the part of the recipient (i.e. the target shareholders), including where the allocation is automatic following a decision by a court, that allocation should not qualify as an offer of securities to the public.

However, there has long been uncertainty over the position where target company shareholders are given a choice to accept either cash or securities issued by the bidder in exchange for their shares in the target company (a so-called “mix and match facility”). Historically, the FCA’s position has been that this element of choice gives rise to the need to publish a prospectus.

Proposed new Technical Note TN/606.1 would confirm this position. The draft note states that, where a target company shareholder is asked to choose between different forms of consideration, the FCA’s view is that an issuer may reasonably conclude that a prospectus should be produced (unless any exemptions are available), because the investor is deciding to buy or subscribe for securities and the allocation of securities is not automatic (as contemplated by Recital 22).

The note specifically refers to a scheme of arrangement that includes a mix and match facility offering a choice between shares and cash as an example of this kind of scenario.

The proposed Technical Note frames this as the FCA’s own interpretation of the law and not a definitive rule. The draft note ends by stating that issuers (i.e. bidders) should obtain their own legal advice but may contact the FCA in advance if they are concerned that it may seek to challenge a decision not to publish a prospectus.

Also this week…

  • Companies House to resume compulsory strike-offs. Companies House has announced that it will be resuming compulsory strike-offs from 10 October 2020. It had previously paused both voluntary and compulsory strike-offs during the on-going Covid-19 pandemic. Companies House has previously announced that it will resume voluntary strike-offs from 10 September 2020.
  • FCA and FRC permit early adopting of amended IFRS 16. The Financial Conduct Authority has confirmed that companies required to comply with Rule 4.1 and 4.2 of its Disclosure Guidance and Transparency Rules (which includes companies admitted to a regulated market and certain other listed companies) may adopt modified IFRS 16 for rent concession accounting, notwithstanding that the amendments have not been formally adopted at EU level. The Financial Reporting Council has issued a similar concession.