Corporate Law Update
- The designated members of an insolvent LLP breached their fiduciary duties when they agreed to waive a debt owed to the LLP
- A gift of shares was effective (in equity), even though there was no evidence that the transferor had executed an instrument of transfer
- The Pre-Emption Group extends the relaxation of its Principles to 30 November 2020
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The High Court has found that, by approving the waiver of a debt owed by a former member to an insolvent LLP, the designated members of the LLP breached their fiduciary duties.
Re A&C Restoration LLP (Manolete Partners plc v Riches)  EWHC 1404 (Ch) concerned a limited liability partnership (LLP) that had been placed into liquidation.
Prior to its liquidation, one of the LLP’s designated members had retired. At the time of his retirement, that member owed the LLP a debt of £126,871, representing amounts which the designated member had withdrawn from the LLP in excess of the LLP’s profits.
However, on the member’s retirement, the LLP’s designated members (which included the retiring member) caused the LLP to enter into a retirement deed under which the LLP waived its right to recover this debt. At the time, the LLP was (in the judge’s words) “hopelessly insolvent”.
On the LLP entering into liquidation, the liquidator identified a potential claim against the retired member to recover the debt and assigned it to a third party, whom we will refer to as the “claimant”.
The claimant brought proceedings against the retired member to recover the debt. The claimant cited various grounds of claim, including that the waiver of the debt was a transaction at an undervalue under the Insolvency Act 1986 and so should be set aside.
The claimant also argued that, in approving the debt waiver, the LLP’s designated members had breached their fiduciary duties to the LLP, and that the waiver should therefore be set side.
What did the court say?
The court noted that a LLP’s designated members stand in a similar position to the LLP as the directors of a company stand to that company and owe similar duties.
In this case, because the LLP was insolvent, when deciding whether to agree the waiver on behalf of the LLP, the designated members were required to consider the interests of the LLP’s creditors. (It is well-established law that, when a company is entering the zone of insolvency, the primary focus of the directors’ duties switches from its shareholders to its creditors.)
The judge noted that the LLP’s creditors would obviously suffer if the debt waiver were to be enforceable. The creditors were entitled to expect that the LLP’s designated members would seek to recover the LLP's debts, not release them. Causing the LLP to release the debt could not have been in the creditors’ interests.
As a result, the court concluded that it was “plainly a breach of duty, a misfeasance, to cause the LLP to agree to the waiver in the circumstances of insolvency”. This breach of duty extended to the retiring member, who (as noted above) was a designated member when the waiver was granted.
As a result, the court said that the retiring member could not rely on the waiver of his debt. (In legal terms, he was “estopped” from relying on the waiver.) Alternatively, even if he was able to rely on the waiver, the LLP would have a claim in damages against him for breach of duty.
What does this mean for me?
Compared with companies and directors, there is relatively little case law on the duties owed by the designated members of an LLP. But what law there is, including this most recent judgment, shows that members of an LLP are subject to the same duties that apply to company directors.
Members of an LLP owe duties to the LLP itself (which, as a matter of law, is a person in its own right), not each other. It is possible for members to assume fiduciary duties to each other in particular circumstances, but this depends on the facts in each case.
It is sometimes easy to assume that the role of a designated member is purely an administrative one akin to that of a company secretary, involving convening meetings of the members, keeping the LLP’s books up to date and filing returns. However, although indeed responsible for these administrative tasks, a designated member is still a member of an LLP and subject to the same duties.
Where a member is taking a decision or action on behalf of an LLP, they should ask the following.
- How does the proposed course of action benefit the LLP? Every decision should be taken with the LLP and its interests in mind. Normally, this will involve understanding what ultimately will benefit the members of the LLP.
- What is the LLP’s financial state? If the LLP is in financial difficulty and approaching insolvency, the members, when making decisions, should be focussing primarily on maximising return for the LLP’s creditors.
- Is this the right decision? Generally speaking, whatever the state of the LLP’s financial affairs, members should ensure they exercise reasonable care, skill and diligence when taking decisions, disregard any personal interests and exercise independent judgment.
The High Court has held that an individual made a gift of shares in a company despite the fact that no instrument transferring shares could be found.
Nosnehpetsj Ltd (in liquidation) v Watersheds Capital Partners Ltd  EWHC 1938 (Ch) concerned two companies owned by an individual, which the judge refers to as the “Company” and “Capital”.
The individual held the shares in both companies. In 2010, he appeared to have transferred his shares in Capital to the Company, making Capital a subsidiary of the Company. This was reflected in the Company’s subsequent accounts and annual returns, which showed Capital as a subsidiary.
In 2013, in anticipation of its being struck off, the Company transferred its shares in Capital back to the individual for no consideration (i.e. as a gift). The Company was then struck off and dissolved.
The following year, the Company was restored on the application of a former employee who wished to pursue a claim in the Employment Tribunal. That employee also petitioned the court to place the Company into liquidation. This was granted and the Company was placed into liquidation in 2015.
The liquidator applied to reverse the transfer of shares from the Company back to the individual on the basis that the Company was insolvent at the time and the transfer was therefore in breach of the individual’s duty as a director of the Company. He claimed that the transfer should be reversed so as to restore the shares in Capital to the Company’s ownership or, alternatively, the individual should compensate the Company.
The individual argued that he had never transferred the shares in Capital to the Company. There was no evidence of a stock transfer form to that effect, nor any communications between the individual and his accountant relating to such a transfer.
What did the court say?
The court found that the individual had intended to transfer the shares to the Company.
Although it had not been possible to identify a stock transfer form or any surrounding correspondence to that effect, what evidence there was clearly suggested that the intention had been to place the shares in Capital into the Company’s ownership.
This was not least because doing so would enable the Company to claim a tax relief that would not have been available had the shares remained in the individual’s name. This was underscored by the fact that the existence of that relief was referred to in publicly available documents, and that the Company had formally claimed the relief from HM Revenue & Customs.
The judge found that the individual had made an equitable assignment of the shares to the Company. That is to say, although the shares had not been formally transferred to the Company, the individual had made a gift of them in equity and effectively created a trust over them in favour of the Company. Given the evidence available to the court, it would have been “unconscionable” to deny that gift.
The individual argued that, for the equitable assignment to have taken place, it would have been necessary for him to take all action within his power to complete the assignment, including executing a stock transfer form. However, the judge was not convinced by this and noted the principle that “equity would not strive officiously to defeat a gift”: the mere fact that the individual may not have done anything in his power to complete the transfer would not in itself defeat the gift.
In any case, the judge found that, given the knowledge and experience of the individual and his accountant, there must have been a stock transfer form at the time.
He also found that the transfer of the shares by the Company back to the individual for no value was a breach of duty.
What does this mean for me?
The judgment shows how easy it can be to create a gift, even if the parties fail to see through all of the formalities.
In this case, the judge was convinced that the individual had intended to make the gift and was not prepared to let him disown that gift in the face of insolvency. There were clear reasons why the court might strive to find that a gift had occurred.
However, the facts in a given scenario will not always be as stark as in this case, and a shareholder who has purported to sell or gift shares should not assume that they remain the economic owner of shares merely because they have not formally transferred them.
Conversely, the judgment may be useful where a person has attempted to transfer shares to someone else but failed to complete all the formalities. It is not uncommon for documentation to go missing, or for parties to neglect to see through final steps as they are dragged in different directions by competing priorities. In these cases, there may be some hope that, for certain purposes, it can be argued that ownership did indeed transfer when the parties intended.
Nevertheless, it is important – in some cases, critical – to see through the entire procedure for transferring shares, including executing a proper instrument of transfer.
- Without a proper instrument of transfer, a company’s register of members cannot be updated and the legal owner of the shares will not change. Until this happens, a person who is expecting to acquire shares will need the acquiescence of the previous owner to vote or transfer the shares.
- Because the transferee will not hold legal title, it will be difficult or impossible to grant acceptable security over the shares. This could be a problem if the transferee is intending to use its new shareholding as collateral for a loan.
- Where the shares are being sold for value, the agreement to sell them will give rise to a liability to pay stamp duty reserve tax (SDRT). If there is an instrument of transfer, stamp duty will be payable, which will result in the SDRT liability falling away. But, without an instrument of transfer, no stamp duty will arise so the SDRT liability will stand, possibly for some time, giving rise to penalties and interest.
- This problem is more acute where the transfer is exempt from stamp duty (because it is for £1,000 or less) or benefits from a relief (e.g. intra-group relief or reconstruction relief). Because there are no corresponding reliefs from SDRT, failing to execute a stock transfer form can (depending on how long things are left) mean that a stamp duty relief or exemption that would have applied may not be available.
- Although most companies’ articles allow an instrument of transfer to take any form acceptable to the company’s directors, for fully-paid shares it is usually best to use the standard form of stock transfer form. If this is done, the parties should be able to disregard any specific requirements for the instrument of transfer set out in the company’s articles.
The Pre-Emption Group (PEG) has announced that it is extending the additional flexibility for companies pursuing equity placings that it introduced earlier this year.
In April, we reported that PEG had announced a temporary relaxation of its guidance to assist issuers during the on-going coronavirus outbreak.
Under PEG’s Statement of Principles, issuers are encouraged to limit non-pre-emptive issues of shares to 5% of their share capital for general corporate purposes, and an additional 5% in connection with an acquisition or a specified capital investment.
During the outbreak, PEG has been recommending that investors consider (on a case-by-case basis) supporting issuances of up to 20% of a company’s share capital on a non-pre-emptive basis. Specific, one-off disapplications have remained unaffected. Companies that take advantage of the restriction are expected to take certain steps and satisfy certain conditions set out in PEG’s original announcement.
The relaxation, whose purpose is to ensure companies have access to the capital needed to maintain their solvency, was originally due to end on 30 September 2020.
However, PEG has now announced that the relaxation will continue to apply until 30 November 2020. This is to accommodate the “continuing uncertainties of Covid-19 and the developing pipeline of equity offerings” in Q3 2020. However, the tenor of PEG’s latest announcement suggests that the relaxation will not be extended again after this date.