Corporate Law Update
- Payments to director-shareholders under a share scheme were remuneration, not company distributions
- Amendments improving the contractual benefits of employees transferring under TUPE were invalid, as they were made in connection with the transfer
- The FCA publishes further guidance on half-yearly reports, going concern assessments and shareholder engagement during the Covid-19 pandemic
- The FCA publishes guidance on market abuse during Covid-19
- Brigadier withdraws its request for a review of the Takeover Panel’s ruling in respect of its offer for Moss Bros
- ESMA publishes recommendations to issuers on interim reporting during the Covid-19 pandemic
- Glass Lewis publishes a tracker showing delays to general meetings across the world caused by Covid-19
- The ICGN publishes update anti-corruption guidance for issuers
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 High Court has held that certain payments made to shareholders under an “E share scheme” were in fact remuneration, rather than unlawful distributions by a company. As part of its decision, the court considered the factors that are relevant in deciding whether to characterise a payment as a distribution.
Chalcot Training Ltd v Ralph  EWHC 1054 (Ch) concerned a learning and communications products business owned by two individuals, who were also its directors.
In 2011, on professional advice, the company entered into a so-called “E shares scheme”. The purpose of the scheme was to allow the company to make payments to two individuals without bringing those payments within the scope of PAYE income tax or national insurance contributions (NICs).
To achieve this, the payments were subject to an obligation on the individuals to subscribe for shares in the company via the E shares scheme. This intended effect was that the payments would not be treated as taxable earnings of the two individuals. In addition, the payments would be deductible for the purposes of corporation tax payable by the company.
The company made two rounds of payments to the individuals under the E shares scheme and a third payment to one of the individuals under a related (F shares) scheme.
In 2015, Her Majesty’s Revenue and Customs (HMRC) opened an enquiry into the company’s tax returns and determined that the payments were subject to PAYE income tax and NICs. The company appealed HMRC’s determination and that appeal is currently stayed.
Separately, the company brought proceedings against its own directors, who (as noted above) were also its shareholders. It claimed that the payments were not in fact remuneration, as HMRC had determined, but distributions by the company to its shareholders.
Because those distributions had not been justified and paid in accordance with the Companies Act 2006 (which requires distributions to be justified by reference to relevant accounts), the company claimed that they were unlawful and that the shareholders were required to pay them back.
This had the curious effect of the individuals effectively claiming against themselves (through the company), but there was logic to this. If the court were to find that the payments were unlawful distributions, rather than remuneration, there is no doubt that they would not have been subject to PAYE income tax or NICs, which would in turn nullify HMRC’s determination.
What did the court say?
The court had to consider various issues, including whether the payments were made under a mistake of law. But the key point we are concerned with is how the court characterised the payments.
The judge considered various previous cases on this point. These included:
- Re Halt Garage (1964) Ltd  3 All ER 1016, in which the High Court found that payments made to a director-shareholder who had fallen ill were in fact distributions, even though they were labelled as remuneration, as the individual had not in fact been providing services to the company.
- Aveling Barford Ltd v Perion Ltd  BCLC 626, in which the High Court found that, where one company sold an asset to another company controlled by its shareholder for a price which it knew was below the asset’s market value, the sale was a distribution.
- Progress Property Company Ltd v Moorgarth Group Ltd  UKSC 55, in which the Supreme Court found that the sale of securities by a company to a shareholder below market value was not a distribution, because, although the directors had mistakenly taken into account matters that caused them to undervalue the securities, they had otherwise acted genuinely.
In particular, Progress Property is now regarded as being a pivotal case in deciding whether a payment is a distribution or not. In summary, it establishes two key points:
- Whether a payment is a distribution is a matter of substance, not form. The label attached to the payment is not decisive. This is the so-called “objective approach”.
- The court must ascertain the true purpose and substance of the payment by investigating all the relevant facts. Sometimes, this will include the state of mind of the human beings who orchestrate that payment. This is the so-called “subjective approach”.
To this, the court in this case added the following:
- How the parties choose to describe a payment, both in the documents governing the payment and in documents such as the company's accounts, can also be relevant, because it indicates not only the true nature of the payment but also what the parties considered it to be.
- The court must decide whether there is a genuine exercise of the power to award remuneration or whether that power is being used to disguise payments which are really distributions to shareholders.
- In deciding this, the court will not generally interfere in commercial decisions taken by directors and will allow a wide "margin of appreciation".
In this case, the judge noted that the intended purpose of the E share scheme – to allow payments to be made free from PAYE income tax and NICs, and to allow the company to make corporation tax deductions – depended on the payments being treated as remuneration. If they had been distributions, none of these tax advantages could have accrued.
The company’s board minutes had discussed the payments in the context of the two individuals’ employment arrangements and in recognition of their “contribution” to the company. Moreover, the payments had been recorded in the company’s accounts as “employment expenses”.
The judge rejected arguments that the payments were more akin to distributions because they were calculated based on, and paid out of, the company’s profits or paid proportionately to the individuals’ shareholdings (much like a dividend). In the end, the payments were made in return for services rendered to the company by the individuals.
What does this mean for me?
It seems unlikely that the court was ever going to have much sympathy for the two individuals in this case, who (on advice) had implemented a tax mitigation scheme which depended on them deliberately treating payments as remuneration, only later to attempt to reverse that position when the perceived tax advantages appeared to be falling away. In that sense, this was an opportunistic claim which didn’t really tax the court.
But the case did provide the opportunity to re-examine the principles around disguised distributions. The key point to note is that it doesn’t matter what the company calls the payment – if it is, in substance, a distribution, the courts will treat it as such. However, although a payment will not be a distribution merely because a company’s directors do not intend for it to be one, the directors’ genuine beliefs and behaviour will be indicative when deciding how to characterise the payment.
When making a payment to someone who is a shareholder, companies and their directors should consider the following:
- What is the company getting in return for the payment? If the company is receiving something valuable – whether an asset (such as securities or property) or services (including employment services) – the payment is less likely to be characterised as a distribution. This follows the fundamental principle that a distribution is a voluntary disposition by a company.
- If it is, what is the value of that asset or those services? Generally, the courts will not second-guess decisions taken by directors in good faith as to the value of assets or services. But if whatever the company is receiving in return is clearly worth substantially less than the payment it is making, there is a risk that the difference could be characterised as a distribution.
- What is the directors’ state of mind when approving the payment? “Substance over form” means that directors cannot simply “will” a payment into being, or not being, a distribution. But the courts will attach significant weight to any genuine decisions taken by directors and give them a “margin of appreciation” when deciding whether a payment is, in substance, a distribution.
The Employment Appeal Tribunal (EAT) has held that changes to employees’ contracts following a TUPE transfer were void, even though those changes would have been beneficial to the employees.
Ferguson v Astrea Asset Management Ltd  UKEAT/0139/19 concerned a change in the estate manager for the Berkeley Square Estate in London.
Until September 2017, that manager was Lancer Property Asset Management Limited (“Lancer”), whose sole business was to manage the Estate. In September 2016, the owner of the Estate notified Lancer that it was terminating its appointment as estate manager. In September 2017, it replaced Lancer with a new manager, Astrea Asset Management Limited (“Astrea”).
The change in estate manager amounted to a “service provision change” under the Transfer of Undertakings (Protection of Employment) Regulations 2006, better known as “TUPE”. When a service provision change occurs, provided certain conditions are met, employees of the outgoing contractor (and their employment contracts) will transfer automatically to the new contractor.
In particular, regulation 4(1) of TUPE states that those employees’ contracts “shall have effect after the transfer as if originally made between the person so employed and the transferee”.
Moreover, regulation 4(4) of TUPE states that any purported variation of a contract of employment that is transferred under TUPE is “void if the sole or principal reason for the variation is the transfer”.
However, in June 2017 – that is, after the Estate owner had notified Lancer that it intended to end Lancer’s appointment, but before the transfer to Astrea – the terms of Lancer’s directors’ employment were amended to provide greater benefits to them, including new guaranteed bonuses, new contractual termination payments and (in two cases) longer contractual notice periods. This was done in the expectation that their employment would transfer to Astrea on the amended terms.
Lancer’s employees, including its directors, alleged that they had transferred to Astrea under TUPE. In late September and early October 2017, Astrea gave the four directors notice that it was terminating their employment for gross misconduct.
A key question was whether, at the time they were dismissed, the amendments to the directors’ employment terms were valid or whether they had been nullified by TUPE. Astrea argued that, because the amendments were made in contemplation of the TUPE transfer, they were void. The directors argued that the purpose of TUPE was to protect employees and so it should not nullify any amendments that were beneficial to the employees (i.e. the directors).
In other words, the Tribunal was being asked to interpret whether regulation 4(4) of TUPE also covered beneficial amendments.
Initially, the Employment Tribunal dismissed the directors’ argument. They appealed to the EAT.
What did the Appeal Tribunal say?
The Tribunal agreed with Astrea and found that the amendments were void.
The judge noted that TUPE ultimately derives from the EU Acquired Rights Directive (2001/23), one of the principal purposes of which is to “provide for the protection of employees in the event of a change of employer, in particular, to ensure that their rights are safeguarded” (our emphasis added).
He also observed that safeguarding involves the prevention of something negative or undesirable, as distinct from improving something or making it better. He also noted that previous cases had suggested that changes that benefit an employee would survive a TUPE transfer unharmed.
However, ultimately the judge decided that even positive amendments to someone’s terms of employment will be void if they are made in connection with a TUPE transfer. In reaching this conclusion, he noted the following:
The main purpose of the Acquired Rights Directive (and, therefore, TUPE) is to safeguard employees’ rights, not improve them.
If TUPE were to nullify only variations that are adverse to employees, it would give rise to difficult questions as to whether a variation is "adverse", in turn causing confusion as to what the terms of the employee's contract are.
By nullifying all amendments (beneficial or adverse), TUPE also reduces the possibility of injustice to the transferee employer (such as in this case).
Finally, this approach appears to be consistent with the other provisions of TUPE and literal words of the legislation.
What does this mean for me?
Service provision changes are frequently seen on business sales and corporate reorganisations where an external provider is being replaced.
More commonly, TUPE transfers arise on business sales where the buyer is acquiring the assets and undertaking of the target business, rather than the shares in the company that runs that business. In those circumstances, it is perfectly conceivable that the terms of employment of anyone who transfers with the business – particularly directors and other senior employees – may be amended.
The key point to remember is that any amendments to a transferring employee’s terms of employment, whether beneficial or adverse to the employee, will be void automatically if their sole or principal reason is the transfer.
This does leave open the door to making changes that are occasioned or triggered by a transfer, but which are not caused by the transfer – changes that would have occurred anyway. But it will inevitably be difficult to distinguish these from amendments that are driven solely or principally by the transfer, and transferees should take professional advice before embarking on changing employment terms.
FCA relief for half-yearly reports and guidance on going concern assessments and shareholder engagement
The Financial Conduct Authority (FCA) has published Primary Market Bulletin 28, in which it provides some further updates for listed companies in the context of the on-going Covid-19 pandemic.
The key points arising from the Bulletin are as follows:
- Half-yearly reports. Issuers that need extra time to complete their half-yearly financial reports will have an additional month to publish them. Issuers that publish their half-yearly financials within four months will not face action from the FCA under its Disclosure Guidance and Transparency Rules or be required to request a suspension of their listing. This relief is temporary.
- Going concern assessments. The FCA recognises that issuers will increasingly need to include disclosures in their annual reports regarding the difficulties they face due to Covid-19. It is urging investors and intermediaries not to draw unduly adverse inferences from these disclosures.
- Shareholder engagement. Finally, the FCA is encouraging issuers to engage as openly as possible with shareholders about the implications of Covid-19 on their business. This includes finding alternative means for shareholders to ask questions of issuers.
The Financial Conduct Authority (FCA) has also published its Market Watch 63 newsletter, in which it has provided guidance on the UK’s market abuse regime during the Covid-19 pandemic.
The key points from the newsletter are as follows:
- The effect that coronavirus has had on businesses globally may itself give rise to new inside information. Information that may not have been price-sensitive before may now have become so due to the potential impact on businesses’ prospects.
- Particular items market participants should consider include access to finance and funding, changes in cash-flow patterns, force majeure and termination rights in material contracts, changes to dividends and buy-back schemes, changes in strategy and business plans, business resumption plans, return-to-work plans, and impact on supply chains.
- Issuers should consider whether there have been any material changes to previous forecasts they have published, such as in relation to earnings, revenue or KPIs, that may need to be announced.
- Issuers should also continue to ensure inside information is appropriately identified, controlled, handled and disclosed to the markets. In particular, they should assess whether their internal systems remain adequate, especially in light of any new working arrangements. This might include reviewing controls for restricting access to information on secure IT systems and how staff access to inside information can be supervised remotely.
The newsletter also contains updates on short-selling, and for providers of corporate finance facilities on managing potential conflicts of interest.
Also this week…
- Brigadier withdraws MAC review request. Further to our update last week, the Takeover Panel has confirmed (in Statement 2020/6) that Brigadier Acquisition Company Limited has withdrawn its request for a review of the Panel Executive’s ruling that it was not permitted to invoke certain material adverse change (MAC) conditions in its offer for Moss Bros plc. The Executive’s ruling from last week therefore stands.
- ESMA publishes recommendations for interim reporting. The European Securities and Markets Authority (ESMA) has issued a statement addressing the implications of the Covid-19 pandemic on half-yearly reports (and other interim reports under IAS 34) published by listed issuers, including specific disclosures relating to the impact of Covid-19. In particular, ESMA notes that, whilst issuers may need to delay publication, they should not do so unduly and must continue to comply with the EU Market Abuse Regulation.
- Glass Lewis publishes shareholder meeting tracker. Proxy adviser Glass Lewis has published a tracker showing delays to general meetings of publicly traded companies across the world caused by the Covid-19 pandemic.
- ICGN publishes updated guidance on anti-corruption principles. The International Corporate Governance Network (ICGN) has updated its anti-corruption guidance (originally published in 2009). The guidance emphasises the importance institutional investors attach to issuers taking action to mitigate and fight corruption.