Corporate Law Update

This week:

• A shareholder’s claim against a company for breaching the leaver provisions in its constitution was unsuccessful because the shareholder suffered no loss
• The FCA is consulting on enhanced climate change reporting for premium-listed companies
• Companies House publishes advice on filing accounts in the context of coronavirus
• The Investment Association publishes its Good Stewardship Guide
• Institutional Shareholder Services (ISS) publishes a new Climate Voting Policy
• The European IPO Task Force reports on ways to improve the European IPO markets
• The FCA is consulting on introducing relaxed listing requirements for open-ended investment companies (OEICs)

Leaver provisions were breached but no loss suffered

The High Court has held that a company breached its own articles of association when it failed to initiate a mandatory share transfer under its leaver provisions. However, the shareholder in question had suffered no loss and their claim was rejected.

What happened?

Ajayi v Ebury Partners Ltd [2020] EWHC 166 (Comm) concerned the grant of options by a company to one of its employees (Ms A) under an employee management incentive (EMI) scheme.

In 2013, Ms A was asked to do more work for the company. She was given the option to take some or all of her remuneration in cash and the balance in share options under the EMI scheme. She opted to take just under 90% of her remuneration in share options.

Ms A (on behalf of the company) reached an agreement with HM Revenue & Customs that, for the purposes of the EMI scheme, the shares were valued at a 90% discount to their actual market value.

The term of Ms A’s engagement with the company ended in December 2015, at which point she became a “Leaver” under the company’s articles of association.

As is standard, the company’s articles stated that, when a shareholder became a “Leaver”, they were deemed to serve a transfer notice in respect of their shares, offering their shares to the other shareholders at a stipulated price. The company would act as the shareholder’s agent for this purpose.

If the shareholder were a “Bad Leaver”, that sale price would be the price paid when the shareholder originally subscribed for the shares (which is normally very low). A shareholder would be a “Bad Leaver” if (among other things) they “terminated [their] consultancy” with the company.

If, however, the shareholder were a “Good Leaver”, the sale price would be agreed between the shareholder and the company. If they were not able to agree, the company would instruct an independent expert to ascertain the “fair value” of the shares.

In this case, the mandatory transfer procedure was never initiated. In particular, the company did not instruct an expert to calculate the value of Ms A’s shares. Her shares were never transferred.

Ms A later brought a claim against the company. She said the company had breached its own articles by failing to initiate the mandatory transfer procedure. Had it done so, she would have been designated a Good Leaver and able to transfer her shares for their fair value. Subsequent sale rounds in 2017 suggested this would have been significantly higher than the price she had paid for the shares.

The company, in response, argued that Ms A had in fact been a “Bad Leaver” and so would not have been entitled to realise any gain in the value of her shares.

What did the court say?

The court found that Ms A was a Good Leaver. She had not brought her consultancy with the company to an end and so had not “terminated it”. Rather, the fixed contractual term of her engagement had simply expired in accordance with her contract with the company.

The judge gave various reasons for reaching this conclusion. Particularly persuasive was the fact that, if the company’s argument had been right, then anyone whom the company engaged for a fixed term would automatically be a Bad Leaver when their contract ended, irrespective of their behaviour.

That being so, the company had indeed breached its articles by failing to instruct an expert to value Ms A’s shares.

However, that breach had not caused Ms A to suffer any loss for the following reasons:

• The breach of the articles had not prevented Ms A from selling her shares. On becoming a “Leaver”, the company had become Ms A’s agent to sell the shares. But Ms A still held the title to the shares and was entitled to sell them under the transfer procedure in the company’s articles.
• The mandatory transfer mechanism in the articles did not guarantee a sale of Ms A’s shares. It merely initiated a pre-emptive offer to the company’s other shareholders. The company was under no duty to bring a sale about.
• Although Ms A may have been able to sell her shares at the price reached in the 2017 sale rounds, the evidence suggested that the value of her shares had since increased by a factor of between 1.5 and 3.5. Either way, the shares she was continuing to hold were actually worth more now than the amount she could have obtained in the sale rounds.

What does this mean for me?

The decision is not surprising, although it does provide some useful guidance on how the courts will view leaver provisions and mandatory share transfers.

The fact that Ms A was not a bad leaver merely because her engagement came to an end contractually is to be expected. Bad leaver provisions normally kick in where an employee leaves of their own volition or are released for cause, not where they leave in expected circumstances.

What is interesting is the judge’s conclusion that Ms A had remained entitled to sell her shares throughout. When a shareholder becomes a Leaver, the articles will normally state (as they did here) that they are deemed to serve a transfer notice. This effectively means the Leaver offers to sell their shares to the other shareholders at a price determined by the articles.

In order to sell the shares to a third party, the Leaver would need to withdraw their deemed offer. But this makes little sense in the context of a forced transfer mechanism. Indeed, as in this case, the articles will normally state that the deemed transfer notice is “irrevocable” and cannot be withdrawn.

The idea that, in spite of this, a Leaver could sell their shares to a third party during a forced sale process arguably defeats the purpose of the process: to ensure that existing shareholders have a right to acquire the Leaver’s shares in preference to any outsiders.

The court did say that Ms A had remained “entitled to serve [a voluntary transfer notice] to start the transfer procedure afresh” – that is, to initiate a voluntary transfer procedure. But it is not clear at what point this right would have arisen. In theory, until the transfer price is agreed, the forced transfer is still “live”, and the company’s board would presumably be able to refuse to register the transfer.

Rather than overriding that process completely, an appropriate remedy for the shareholder would seem to be to seek the court’s assistance in forcing the company to procure a valuation. It may be that, in this case, the court felt sympathetic due to the length of time that had passed.

Above all, this shows the need to draft compulsory transfer provisions in articles of association carefully. When drafting a compulsory transfer procedure, the following points are critical:

• Define clearly when someone becomes a Good Leaver or a Bad Leaver. Following this case, consider stating expressly how a person whose contract ends naturally is to be treated.
• Provide clearly that any deemed transfer notice is irrevocable.
• Consider including an express obligation on the Leaver not to transfer their shares or serve a transfer notice under the voluntary transfer (or “pre-emption”) provisions.
• Ensure the articles set out how the Leaver’s shares are to be valued. For a Good Leaver, if the parties cannot agree on a value, it is standard for a company’s articles to require an expert to determine one.

FCA consults on climate change reporting

The Financial Conduct Authority (FCA) is consulting on changes to its Listing Rules to require listed companies to report against the recommendations of the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (the TCFD).

The TCFD was created in 2015 to develop recommendations for climate-related disclosures. In June 2017, it published its Final Report, setting out eleven specific recommendations. These have quickly become a globally recognised framework for developing consistency in climate change reporting.

The FCA’s proposed changes would require premium-listed commercial companies to confirm whether they have made disclosures in their annual report consistent with the eleven recommendations in the TCFD’s Final Report. If a company were not to do so, or if its disclosures sit outside the annual report, it would need to give an explanation.

This effectively amounts to a “comply or explain” requirement, not wholly dissimilar to the existing obligation to report against the UK Corporate Governance Code.

The FCA is also proposing to publish a new technical note outlining how the new obligation would interact with existing disclosures under the FCA Handbook and the Market Abuse Regulation.

The new requirement would not apply to investment companies or companies with a standard listing.

The FCA has decided against introducing mandatory disclosures at this point, as it recognises that not all issuers will have the capability to do so. However, it has said that the proposed changes are a “first step” towards adopting the TCFD’s recommendations more widely and that it expects to consult on expanding and strengthening climate change reporting in the future.

UK listed companies are already required to disclose metrics on greenhouse gas emissions and energy usage and to include information on how their business impacts on the environment and their environmental policy. In addition, existing obligations to report on their risks and strategy and how their directors have discharged their duties may well prompt environment-related disclosures.

Other items

• Companies House advice on accounts and coronavirus. Companies House has published advice to UK companies on the impact of coronavirus on filing their accounts. It says that, if, immediately before the filing deadline, it becomes apparent that accounts will not be filed on time due to effects caused by coronavirus, a company can apply to extend the period for filing. If a company does not apply for an extension and its accounts are filed late, an automatic penalty will be imposed. The registrar has very limited discretion not to collect a penalty.
• IA publishes Good Stewardship Guide. The Investment Association has published its Good Stewardship Guide for 2020. The Guide provides an overview of some key themes that are common to all UK listed companies and which are likely to be of particular focus in 2020. The guide focuses in particular on climate change reporting and risks, gender and ethnic diversity, audit quality, executive pay and pensions, and dividend policies.
• ISS publishes climate voting guidelines. Global proxy adviser Institutional Shareholder Services (ISS) has published a new thematic Climate Voting Policy to “allow investors to integrate climate-related factors into their voting decisions”. The new policy supplements ISS’s other existing thematic policies. It draws on existing frameworks, including the TCFD’s recommendations (see above) and is designed to be used across different jurisdictions.
• Task Force reports on European IPO markets. The European IPO Task Force has published recommendations to improve conditions for European IPO markets. The report notes that the level of European IPOs has been falling for more than 20 years, and that the consequent concentration of business in private companies is leading to less transparency. It sets out suggestions for dealing with this, including possible cultural, regulatory and tax reforms.
• FCA consults on relaxed requirements for OEICs. The Financial Conduct Authority (FCA) is consulting on relaxing the listing requirements for open-ended investment companies (OEICs). In particular, it is proposing to disapply the rules requiring shareholder approval for a wide variety of matters (including related party transactions), remove the need for an OEIC to have a sponsor, and reclassify an OEIC’s premium listing as a “standard listing”. The purpose of the proposed changes is to create a “more proportionate” listing regime that recognises the particular business model of OEICs. The FCA has asked for comments by 9 June 2020.