Corporate Law Update

• The court clarifies the test for a member of an LLP to bring a derivative claim against another member
• The FRC publishes updated guidance on company general meetings during Covid-19
• The court sanctions a company takeover despite beneficial owners of the target’s shares not being able to vote on the scheme
• The London Stock Exchange extends the deadline for AIM companies to file half-yearly reports
• Companies House updates its striking-off policy during the Covid-19 pandemic
• Companies House is now allowing certain forms to be uploaded
• The Corporate Insolvency and Governance Bill proceeds to the House of Lords
• The European Commission publishes draft regulations to correct errors in the EU prospectus regime
• The FCA publishes guidance for public bodies on identifying and handling inside information

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 test for bringing derivative claim against LLP members

The High Court has clarified how a member of a limited liability partnership (LLP) can bring a derivative claim on behalf of the LLP against another member.

Background

Homes for England v Nick Sellman (Holdings) Ltd [2020] EWHC 936 (Ch) concerned an LLP incorporated to hold the title to an apartment complex in Bedford, England. The LLP had two members – Homes for England (“HOE”) and Nick Sellman (Holdings) Limited (“Holdings”) – who each held 50% of the LLP’s interests. The hearing was an appeal from an earlier county court judgment.

In January 2018, HOE procured a loan facility to refinance the LLP’s existing indebtedness. HOE was keen to put that facility in place before the end of January 2018 so as to avoid the LLP incurring late repayment charges on its existing indebtedness. HOE sent Holdings documentation for it to execute to put the refinancing in place, but Holdings did not execute the documents until late February 2018. As a result, the LLP incurred the additional charges.

HOE claimed that, by not executing the documentation promptly, Holdings had breached certain duties it owed towards the LLP. However, because the charges had been incurred by the LLP and not by HOE directly, it was the LLP (and not HOE) that would need to bring proceedings against Holdings. HOE therefore asked the court for permission to bring proceedings on the LLP’s behalf.

This is similar to a situation where a shareholder in a company wishes to bring proceedings against the company’s directors for breach of duty, but can’t do so in its own name, because the directors’ duties are owed to the company and it is the company that has the right of claim. In those circumstances, the shareholder can ask the court for permission to bring the claim on the company’s behalf.

In either case, this kind of action is known as a “derivative claim”.

The legal context

A shareholder who wants to bring a derivative claim on behalf of a company must follow a procedure set out in section 261 of in the Companies Act 2006 (the “Act”). The court must then decide whether to allow the claim to proceed.

Section 263 of the Act sets out how the court reaches its decision. In certain cases, the court must refuse the claim. This is known as the “statutory stop” or “statutory break”. These include where a person acting in accordance with section 172 of the Act – the duty of a director to promote the success of the company – would not bring the claim. Otherwise, the court can allow the claim, but it must take certain things into account. These include whether the claim is made in good faith, and the importance a person complying with section 172 would attach to it.

The parties initially fought their claim in the county court on the basis that the statutory test in the Act applied to HOE’s claim. In part this was because the Civil Procedure Rules 1998 (the “CPR”) set out the procedure for a derivative claim on behalf of an LLP, and they refer explicitly to the Act.

In particular, CPR 19.9C(4) states that, for a derivative claim on behalf of a body corporate that is not a company (for example, an LLP), “[t]he procedure … under section 261, 262 or 264 (as the case requires) of the Companies Act 2006 applies … as if the body corporate … were a company.”

The county court judge decided the claim on this basis, considered the factors in section 263 of the Act, and allowed the claim to proceed.

Holdings appealed to the High Court. It said that, although the parties had previously agreed that the statutory test applied, that approach was in fact wrong. Rather, the test was set out at common law. This was significant because the common law test for bringing a derivative claim is very different from the statutory test. A claim that might proceed under the Act may well fail at common law.

At common law, a derivative claim is not possible because of the so-called “rule in Foss v Harbottle”, namely that only a company can sue for its own loss (and not a shareholder). However, a derivative claim is possible if it falls within one of four exceptions.

The only relevant exception here was a potential “fraud on the minority”. This required HOE to show either that Holdings had acted fraudulently, or that the LLP had suffered a loss and Holdings made a gain. At no point did HOE suggest that Holdings had acted fraudulently, so HOE’s main task was to convince the court that Holdings had benefitted from failing to execute the documents.

The court therefore had to decide two things:

• Did the statutory test or the common law test apply to HOE’s claim?
• If the common law test applied, had Holdings made a personal gain?

In reaching its decision, the court had to consider a difficult contradiction. In an earlier case (Harris v Microfusion 2003-2 LLP [2016] EWCA Civ 1212), the Court of Appeal had confirmed that the statutory test did not apply to derivative claims on behalf of LLPs. But the court in that case had not considered the CPR, nor whether they effectively applied the statutory test to derivative claims on behalf of LLPs.

What did the court say?

The court agreed that the common law test applied, and not the statutory test. The judge gave two main reasons:

• Although LLP legislation applies several parts of the Companies Act 2006 to LLPs, it does not specifically apply the parts of the Act incorporating the statutory test.
• The CPR do impose parts of the Act relating to derivative claims on LLPs (and other corporations). But CPR 19.9C refers only to sections 261, 262 and 264. It conspicuously omits any reference to section 263, indicating that it was never intended to apply the statutory test.

The result is that, although a member of an LLP must bring a derivative claim under the procedure in the Act, the court must evaluate the claim using the common law test.

In this case, the judge said the common law test had not been met. The LLP had suffered loss, because it had incurred additional charges, but Holdings had not gained any corresponding benefit. Holdings’ appeal was therefore successful and HOE was unable to bring its claim.

What does this mean for me?

This does seem to be the right decision. It’s clear that section 263 has not been expressly applied to LLPs, and it’s hard to see how (as HOE argued) it could apply by implication. Apart from the fact that section 263 consistently refers to “the company”, one of its key tests is whether someone “acting in accordance with section 172” of the Act would bring the claim. But section 172 does not apply to LLPs.

Perhaps the key point to bear in mind from this judgment, therefore, is that, although they follow company legislation in many places, LLPs operate fundamentally differently from companies. The relationship between an LLP and its members is not the same as that between a company, its members and its directors.

In particular, the statutory duties of directors in the Companies Act 2006 do not apply to LLP members. Rather, the relationship between an LLP and its members, and the types of claims members can bring, are regulated by separate legislation and, to a significant extent, by common law.

It’s also worth remembering that the common law test still exists in other cases, such as where a limited partner brings a claim by a limited partnership against its general partner (Certain partners v Henderson PFI Second Fund II LLP [2012] EWHC 3259 (Comm)) or where a shareholder of a holding company brings a claim by a subsidiary against the subsidiary’s directors (a “double derivative claim”) (Universal Project Management Services Ltd v Fort Gilkicker Ltd [2013] EWHC 348 (Ch)).

In these cases, the key questions to ask when evaluating the likely success of a derivative claim will usually be:

• Did the member, partner or director in question act illegally?
• Did they act fraudulently?
• If they didn’t act fraudulently, did the LLP, partnership or subsidiary suffer a loss and, if it did, did the member, partner or director in question make a corresponding personal gain?

Updated guidance on company meetings published

The Government and the Financial Reporting Council (FRC) have published updated guidance to companies on holding AGMs and other general meetings during the Covid-19 pandemic.

The guidance reflects the current passage of the Corporate Insolvency and Governance Bill through Parliament. If passed, the Bill will permit companies and other kinds of corporation to hold virtual general meetings for a limited period of time and will ratify any virtual meetings held since 26 March.

The updated guidance makes the following key points:

• Companies may not need to use the full flexibility to be offered by the Bill. They should monitor their position and take a view on what approach best balances the safety of shareholders and shareholders’ legitimate expectation that they will be able to engage with the board.
• Where a meeting of all members is not possible, companies should consider whether (with the consent of their shareholders) to convene a physical meeting with a representative cross-section of members, allowing shareholders to ask questions in advance.
  
  This appears to be predicated on the Bill becoming law. If passed, the Bill would allow a company to hold a physical general meeting and yet disallow members from attending in person, provided they can still vote. However, in doing so, the directors would need to ensure they are acting fairly as between shareholders. The guidance also suggests that companies should consider accommodating shareholders by holding further events later in the year.

• If it is not safe to allow people to attend in person, a company should consider holding a virtual general meeting. If it is not possible for members to participate via technology, a company could consider streaming their AGM proceedings in real time via their website.
• Companies should exhibit exemplary shareholder communication. This includes issuing communications in a timely fashion, giving clarity on proxy voting, explaining the procedure for the meeting, giving shareholders the opportunity to ask questions and offering physical meetings once lockdown is lifted.

Interests of beneficial owners were irrelevant on a takeover scheme

The High Court has sanctioned a statutory scheme of arrangement to implement a public company takeover, even though many of the beneficial owners of the shares were not informed of the scheme.

What happened?

In the matter of Sirius Minerals plc [2020] EWHC 1447 (Ch) concerned the takeover of Sirius Minerals plc by Anglo American plc.

The takeover was to be implemented by way of a statutory scheme of arrangement under the Companies Act 2006. For a scheme to proceed, it must be approved by each class of the target company’s shareholders. The required threshold is a majority of those attending the meeting who, together, represent at least 75% in value of the shareholders in that class.

Once that has happened, the court must then decide whether to “sanction” the scheme. Generally speaking, a court will sanction a scheme unless it feels there has been a “blot” on it – a defect in the scheme, such as a failure to follow required procedure or some material oversight or miscarriage (such as a defective disclosure in the scheme circular).

In this case, there was a single class of shareholders and the threshold was satisfied. However, although Sirius had only 4,628 registered shareholders, a number of them were nominees who were holding shares on behalf of individuals. This is a common way to own shares in traded companies. The nominee holds registered title on behalf an investor, who holds a purely economic (beneficial) interest.

When “looking through” the nominee structures, it appeared that there were “tens of thousands of small investors” who had a beneficial interest in Sirius’ shares. Many of these were unsophisticated investors who had originally bought their shares for 20 pence per share, but who would receive only 5.5 pence per share if the takeover were successful. (That said, if the takeover failed, Sirius was very likely to enter administration, leaving those shareholders with even less or nothing.)

One of the shareholders objected to the scheme on the basis that there had not been sufficient publicity to alert Sirius’ beneficial owners to the scheme and that several nominees had not contacted beneficial owners to ask how they would like the nominee to vote on their behalf. As a result, he said, the vote to approve the scheme was not representative of the beneficial owners’ views.

The court had to decide whether this represented a “blot” on the scheme, such that it should refuse to sanction it.

What did the court say?

The court sanctioned the scheme.

The judge said that the fact that many beneficial owners did not have an opportunity to vote was not directly relevant to whether Sirius’ shareholders had been fairly represented at the meeting to vote on the scheme. Beneficial owners are not members for the purposes of the Companies Act 2006 and so the court cannot factor this into its decision.

He acknowledged that, if enough beneficial owners had instructed their nominees to vote against the scheme, the outcome might have been different. But Sirius had no obligation to contact beneficial owners of its shares and could not be “blamed” if beneficial owners did not take action.

Moreover, even if Sirius had informed all of its beneficial shareholders, there was no way of knowing how they would have instructed their nominees to vote. It might have been that the scheme would have been approved anyway, and so, even if it had been a relevant factor, the judge could not conclude the vote, as it actually took place, was unrepresentative of the beneficial owners’ views.

There was also no indication that the registered members who did vote, including the nominees, did so other than in good faith. They were “clearly voting to salvage such value as could be salvaged”, particularly when the alternative to the takeover was likely insolvency.

What does this mean for me?

Although set in the context of a scheme, the decision here recognises a broader issue in relation to ownership of shares in a company and voting at company meetings.

It is (currently) a cardinal principle of company law that the only person entitled to exercise rights in relation to shares is the registered holder of those shares. This includes rights to vote at meetings, to receive dividends, to take up shares on pre-emptive offers, to requisition a general meeting or circulate a statement or to attempt to sue directors in the company’s name. Indirect, beneficial owners enjoy none of these rights. Articles of association typically reinforce this principal by noting that the company is not obliged to recognise trusts.

However, the position is not always clear. As we reported recently in SL Claimants v Tesco [2019] EWHC 2858 (Ch), the court held that beneficial owners of shares in a company can claim under section 90A of the Financial Services and Markets Act 2000 if they suffer a loss because of misleading statements published by the company.

The problems that accompany pure beneficial ownership are well known, and in August 2019 the Law Commission launched a call for views on whether any changes should be made in this area of the law. That call for views closed in November 2019. For more information, see our previous Corporate Law Update.

Although there is not always much choice, a person who is considering acquiring shares in a company should think carefully about whether to do so through a nominee or custodian, or rather to acquire and hold them in their own name.

If holding through a nominee, it is important to review and understand the terms of the nominee arrangement. Key terms to check include:

• Is the nominee required to consult the beneficial owner before voting at meetings of the company (or, for private companies, on written resolutions)?
• Does the beneficial owner have the right to instruct the nominee on how to take any action relating to the shares? Does the nominee have any discretion to refuse any instructions?
• Is the nominee required to forward on any correspondence received from the company? If not, how will the beneficial owner gain access to this information?
• Can the beneficial owner claim against the nominee if the nominee fails to do any of these things? To what extent has the nominee limited its liability?

Also this week…

• AIM Regulation extends half-yearly filing deadline. The London Stock Exchange AIM Regulation team has published an Inside AIM article confirming that, with effect from 9 June 2020, the deadline for an AIM company to notify its half-yearly report has been extended from three months to four months. The extension is temporary while the UK faces the disruption resulting from the Covid-19 pandemic and will be kept under review. An AIM company that wishes to utilise the extension must notify its intention to do so via an RIS before its reporting deadline, and its nominated adviser must inform AIM Regulation separately.
• Companies House updates striking-off policy. In late April, Companies House announced changes to its striking-off procedure to help businesses during the Covid-19 pandemic. These included suspending voluntary strike-offs initiated by a company’s directors (to give creditors and others more time to object) and compulsory strike-offs when a company fails to file its accounts or confirmation statement (to give companies time to bring filings up to date). Companies House has now announced that, from 1 June 2020, it will not suspend a strike-off if, following an investigation by its law enforcement partners, it concludes that the company is no longer in operation.
• Companies House now allowing forms to be uploaded. Companies House has announced that it is now possible to upload certain forms that previously needed to be filed in paper form. The new upload service applies to Forms RP02A, RP02B, RP03, RP06, RP07 and RPCH01 (and the equivalent forms for limited liability partnerships (LLPs)). It intends to open the service up to Forms CC01, CC02, CC04, CC05 and CC06 later this month, then in due course to submission of articles of association, company resolutions and certain insolvency forms.
• Changes to insolvency and company law go to the Lords. The Corporate Insolvency and Governance Bill has cleared its third reading and pass to the House of Lords for consideration. Minor amendments have been made to the Bill since it was introduced to the House of Commons, but there has been no change to the provisions affecting company filings and meetings. The House of Lords will now consider whether to make any amendments to the Bill.
• EU publishes draft regulations under prospectus regime. The European Commission has published two draft delegated regulations in connection with the EU prospectus regime (which, for the time being, continues to apply in the UK). The first draft regulation would correct errors in Commission Delegated Regulation (EU) 2019/979, which regulates the publication of prospectuses and prospectus supplements. The second draft regulation would correct errors in Commission Delegated Regulation (EU) 2019/980, which governs the format, content, scrutiny and approval of a prospectus. The draft regulations would take effect 30 days after being published in the Official Journal, apart from certain amendments under the second draft regulation which would have retrospective effect from 21 July 2019. Assuming that the draft regulations take effect before the EU/UK implementation period ends (currently, 31 December 2020), they will apply in the UK following Brexit.
• FCA publishes market abuse guidance for public bodies. The Financial Conduct Authority (FCA) has published Primary Market Bulletin 29, in which it summarises feedback to its consultation in Primary Market Bulletin 25 in November 2019 on a new best practice note for public bodies when identifying inside information. The FCA has adopted the guidance note in substantially its proposed form but with a few small amendments, including the extent to which inside information can be disclosed pursuant to a Freedom of Information Act 2000 request.