Corporate Law Update
- The High Court interprets the meaning of “fair value” in the context of a forced share transfer
- The Law Society, the City of London Law Society and the Foreign Affairs Committee publish their comments on the proposed national security regime
- ICSA: The Chartered Governance Institute publishes the findings of its review into independent listed company board evaluations
- AIM Regulation extends its temporary relaxation for AIM companies to publish their half-yearly and annual reports
- The FCA, FRC and PRA issue a joint statement reminding listed companies of temporary Covid-19 measures
- The Association of Investment Companies is to launch individual investment company ESG disclosures
- Glass Lewis publishes guidance on its executive pay policy during the Covid-19 pandemic
- Companies House defers the closure of Companies House Direct and WebCHeck
- Companies House pauses striking off services
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, where one shareholder amended a company’s articles to allow him to forcibly acquire the other shareholder’s minority holding at “fair value”, the value of those was discounted to reflect the minority shareholding.
In the matter of Euro Accessories Ltd  EWHC 47 (Ch) concerned a company whose business was the supply of various construction accessories.
The company was incorporated in December 2000 by a Mr Gilsenan, who held all of the shares in the company. In 2003, a Mr Monaghan joined the company as a sales representative. In February 2008, Mr Gilsenan transferred 24.99% of the company’s shares to Mr Monaghan, retaining a controlling stake of 75.01% himself.
Around January 2010, the relationship between the two shareholders broke down and Mr Monaghan tendered his formal resignation. Negotiations began for Mr Gilsenan to buy Mr Monaghan’s 24.99% stake back from him. However, the two shareholders were unable to agree a price for the stake.
This continued for a number of years until, in March 2016, Mr Gilsenan proposed a series of special resolutions, which he passed as the majority shareholder, with the following effect:
- Mr Gilsenan’s shares were converted into “A” shares and Mr Monaghan’s shares into “B” shares.
- The articles were amended to give the B shareholder (i.e. Mr Gilsenan) a right, by written notice, to force the A shareholder (i.e. Mr Monaghan) to sell the A shares to the B shareholder for “fair value”.
In April 2016, Mr Gilsenan sent Mr Monaghan a notice under the amended articles requiring Mr Monaghan to sell his shares to Mr Gilsenan for a total price of £175,000. Mr Monaghan did not comply and so Mr Gilsenan ultimately implemented the share transfer himself using a power under the amended articles to do so.
A few years later, Mr Monaghan brought legal proceedings. He did not dispute that Mr Gilsenan had a right to forcibly buy his stake. However, he claimed that the amount he should be paid – the “fair value” of his shares – was a pro rata proportion (i.e. 24.99%) of the total value of the company’s shares.
Mr Gilsenan argued that “fair value” of Mr Moneghan’s shares needed to include a discount to reflect the fact that they represented a minority stake in the company and that control rested with Mr Gilsenan.
Mr Monaghan argued that no discount should be applied for three main reasons:
- The amended articles gave a majority shareholder an “unrestricted right to expropriate the shares of the minority at will” without cause and at any time. No reasonable businessperson would think that Mr Monaghan was a willing seller who would agree to a discount.
- The ordinary meaning of “fair value” was akin to that given in the 2013 edition of the International Valuation Standards of the International Valuation Standard Council (IVSC).
- The “fair value” of the shares was one that was “just and equitable in the circumstances”. Here, the shareholders were parties to an arrangement of mutual trust and so it would be unfairly prejudicial to Mr Monaghan to apply a discount.
The parties jointly instructed a single valuer to decide the value of the total share capital and the discount that should be applied if a discount were warranted. She calculated that value at £2.18 million and the discount at 55%. This meant that, if no discount were applied, Mr Monaghan would receive £545,000 for his shares and, if a discount were applied, he would receive £245,000.
The question for the court was: did the phrase “fair value” require a discount to be applied?
What did the court say?
The judge agreed with Mr Gilsenan and ordered that the discount was to be applied.
The key question was how the phrase “fair value” in the amended articles was to be interpreted.
A company’s articles of association are a contract between it and its members and so the usual principles apply when interpreting a contract. These are now set out in a trio of Supreme Court judgments – Rainy Sky SA v Kookmin Bank  UKSC 50, Arnold v Britton  UKSC 36 and Wood v Capita Insurance Services Ltd  UKSC 24 – and allow the courts to consider both the literal meaning of the words and the factual context in which the contract was made.
However, the judge also noted that, when interpreting a company’s articles association, the courts will not take all of the factual background into account. They will have regard only to any facts that any reader would reasonably be expected to know (Attorney General of Belize v Belize Telecom Ltd  UKPC 10). This is for two reasons:
- Unlike a commercial contract, articles of association are not usually the product of a commercial negotiation leading to a meeting of minds.
- A company’s articles are a public document and have to be capable of being understood by anyone who inspects them.
As a result, when interpreting a company’s articles, a court will look at the natural meaning of the words, how they are used in the articles, any readily ascertainable facts about the company, and commercial common sense.
In this case, the judge noted the following:
- A third party would see that Mr Gilsenan introduced the buy-out right as the holder of 75.01% of the company’s shares. At most, an “astute and assiduous” reader might conclude that Mr Monaghan had not agreed to the right, given his signature did not appear on the written resolution.
- The breakdown between Mr Gilsenan and Mr Monaghan would not have been apparent to a third party and so it could not be taken into account when interpreting the company’s articles.
- There was nothing in the articles that pointed towards the meaning of “fair value”. However, importantly, the articles stated: “the consideration payable for the Sale Shares … shall be … fair value”, which suggested that the focus was on the property, not the identity, of the shareholder.
- Previous cases suggested that, unless the articles state otherwise, a discount should be applied to a minority stake. To attribute a proportionate value of a company’s total value to a minority stake is to attribute part of the “control value” of the company to a stake that confers no control. The fact that Mr Gilsenan could exercise the option at any time and without limit in time did not indicate that a different approach should be taken.
- There was no reason to pick the 2013 IVSC definition of “fair value” over and above any other definition. The articles did not refer to the 2013 Standards, and third party would not necessarily have made a connection with them. Indeed, the 2013 Standards had been superseded by new standards in 2017 precisely to avoid confusion between different concepts of “fair value”.
- Even if inserting and exercising the buy-out right amounted to unfair prejudice (and the court did not think it did), there was no reason why a discount should not nonetheless be applied. A discount had been applied in previous, similar cases.
What does this mean for me?
The judgment in this case helpfully re-establishes some of the principles that apply when interpreting a company’s articles, as opposed to a standard commercial contract. In particular, members of a company should avoid falling into the trap of re-visiting historic negotiations when trying to work out what a provision in a company’s articles means, as a court is very unlikely to take these into account.
However, perhaps the more relevant point for anyone who is negotiating a set of articles, or indeed any kind of contract, that bases payments on the “value” of an asset is to make it clear how that value is calculated. It is common to for contracts to be drafted using phrases such as “market value”, “fair value” or (perhaps most awkwardly) “fair market value”, but these phrases can have different meanings to different people.
When fixing a value, it is worth bearing a few points in mind:
- Explain what is meant by the phrase “value”. This could be achieved by reciting a commonly used accounting definition, or by referring to a definition in appropriate accounting or audit standards. The 2017 edition of the International Valuation Standards is not a bad place to start.
- Use terminology that is understood by financial experts, especially valuers. Phrases such as “market value”, “fair value” and “equitable value” are often easier for valuers to pin down, as they often focus on identifiable principles. By using an established phrase, it may be possible to calculate the value with some certainty even if the contract does not set out a specific definition.
- Avoid non-technical phrases with no established meaning. A common offender is the phrase “fair market value”, which is commonly used in the United States but which is not a term of art in the UK and which confuses the concepts of “market value” and “fair value”.
- Cater for any special factors. For example, in the context of shares, make it clear whether a discount will be applied to the value of a minority stake or, conversely, a premium attached to the value of an asset that, if acquired, will give the buyer a controlling or blocking stake.
- Include a determination mechanism. Court proceedings can be costly. Often the easiest way to resolve a dispute is to appoint an independent expert, such as an accountant or valuer, to value the asset. A good determination mechanism will state that the expert’s valuation will, in the absence of any gross or manifest error, be binding on the parties.
We continue to monitor reaction to the Government’s proposed National Security and Investment Bill (the Bill), which, if enacted, would introduce a new power for the Government to screen and, if appropriate, block acquisitions and investments that pose a risk to the UK’s national security.
The Foreign Affairs Committee
The House of Commons Foreign Affairs Committee (FAC) has published a report setting out a critique of the Bill. The FAC supports the introduction of a new national security regime, but notes certain specific areas of weakness in the Bill as currently drafted.
In particular, the FAC makes following comments.
- “National security”. The lack of a definition in the Bill of the concept of “national security” may lead to the “politicisation” of the decision-making process. The FAC notes that this could lead to a high volume of cautious voluntary notifications, a reduced attractiveness of the UK to foreign investors, difficulties for staff in assessing transactions, and intervention on “economic”, rather than national security, grounds.
The FAC therefore recommends setting out clearly in the Bill what may or may not constitute a national security risk in the context of foreign investment. It notes that similar regimes in other jurisdiction do not provide an exhaustive definition of “national security”, and that setting an overly specific definition could limit the ability to protect UK businesses from unforeseen security risks.
- Clarity surrounding process. There is a lack of transparency about the process by which the Government will make decisions under the new regime. The FAC notes a number of factors that other respondents have suggested could be taken into account when the Government considers a transaction. These include the degree of control being acquired, the acquirer’s intent and the strategic objectives of its country of origin, the impact on the UK’s security of supply in critical sectors, and the impact on the UK’s bilateral relations and geopolitical interests.
The FAC suggests that any decision factors could be hard-wired into the Bill itself and proposes amended wording to this effect. Alternatively, if that is not possible, it suggests including further clarity in the Statement of Policy Intent to which the Government is required to have regard when exercising its call-in power.
- Call-in period. The five-year period within which the Government would be able to scrutinise and potentially unwind a transaction after it has completed may span successive governments. The FAC is concerned that this could lead to an inconsistent application of the regime.
- Resourcing. The extensive scope of the Bill, coupled with the significant penalties set out in it, may lead to a significant volume of voluntary notifications which the new Investment Security Unit (ISU) may not have the capacity to manage or appropriately triage.
The Law Societies
Separately, the Company Law Committees of the Law Society of England and Wales and the City of London Law Society have published their response to the Government’s recent consultation on the sectors that should trigger a mandatory notification under the regime.
For more information on that consultation and the proposed new national security regime generally, see our previous Corporate Law Update.
The Committees make the following key points, many of which mirror similar concerns voiced by the British Private Equity and Venture Capital Association (BVCA) in its response to the consultation (see our previous Corporate Law Update).
- The proposed mandatory notification regime is materially disproportionate in view of the extra-territorial scope of the proposed regime, the lack of any de minimis transaction thresholds or safe harbours, and the facts that transactions would be automatically void and criminal sanctions would apply.
- The proposed breadth of the mandatory notification regime and the proposed sectors may force investors into taking an overly-cautious approach. Investors might make a voluntary notification even if they do not think a mandatory notification is required.
- This may generate a far higher volume of notifications than the Government anticipates, in turn leading to process delays that could portray the UK in a bad light if the new ISU is not adequately resourced.
- The proposed mandatory notification regime could also deter certain types of foreign investor that are valuable to the UK. It could also adversely impact foreign investment in the UK, including in sectors key to the UK’s recovery from the Covid-19 pandemic, and cause serious damage to the UK as a hub for the technology sector.
- The breadth of the 17 proposed sectors should be materially narrowed. The definitions proposed are broad and could capture businesses and assets that do not present national security concerns. The Committees believe there is limited benefit to a broad mandatory notification regime, as the Government would have the ability to call transactions involving a national security risk, even if the transaction does not fall within the mandatory notification regime.
- There will be significant logistical and resourcing issues if all 17 sectors become subject to mandatory notification at the same time. The Committees recommend phasing the sectors in gradually, with the regime applying initially only to the sectors that already fall within the UK’s merger control regime under the Enterprise Act 2002.
- The proposed mandatory notification regime is more onerous than equivalent regimes in other jurisdictions. This approach will be disproportionate and harmful to the UK and is at odds with UK’s post-Brexit objective of being an open and international trading centre.
- The Government should introduce a de minimis threshold to exclude small transactions from the regime. Alternatively, it should build materiality levels into the definition of the mandatory notification sectors themselves. The Committees note that the Government’s consultation adopts this approach for some sectors (such as “Energy”) but not others.
- In addition, the Government should introduce safe harbours based on industry and technical feedback for areas that the Government is not seeking make subject to mandatory notification. The Committees cite the Government’s proposed definition of the “Advanced Robotics” sector as a useful example.
- The definitions of “Artificial Intelligence”, “Communications” and “Data Infrastructure” are broad and could potentially catch almost any business in the UK. The Committees go on to outline high-level concerns for these specific sectors.
Finally, the Committees provide some detailed comments on various specific sectors.
ICSA: The Chartered Governance Institute has released the findings of its review into the effectiveness of independent board evaluation in the UK’s listed company sector.
The purpose of the review, which was carried out at the Government’s request, is to assess the quality of evaluations and to explore how that quality might be improved. For more information on the review and on the Institute’s previous consultation, see our previous Corporate Law Update.
In the final report, the Institute considers there is scope for broader adoption of good practice and greater transparency from both board reviewers and listed companies. It suggests that these should be pursued initially through voluntary initiatives.
To this end, the report sets out 15 voluntary recommendations, including the following.
- Any actions to improve external board performance reviews must be addressed to both companies and reviewers and enhance the ability of shareholders and other stakeholders to hold them to account.
- There should be a Code of Practice for organisations conducting external board performance reviews for FTSE 350 companies. The code would be voluntary, but signatories would be expected to apply it on an “apply and explain” basis. (This is a similar approach to that taken for the Stewardship Code published by the Financial Reporting Council (FRC).)
- There should be Principles of Good Practice for listed companies and other organisations covering the selection of an external board reviewer and how the review will be conducted and reported on. Again, these principles would be voluntary.
- The FRC should issue voluntary guidance to listed companies on reporting against Provisions 21 and 23 of the UK Corporate Governance Code (which require companies to make disclosures relating to board evaluation). This should require companies to disclose whether their reviewer has signed up to the proposed new Code of Practice.
- Board reviewers should be able to provide other services to their clients, but reviewers and companies should explain how they have managed any conflicts of interest or threats to the reviewer’s independence. Companies should indicate in their annual report whether the board performance review fees exceed those paid for other services.
- The FRC (and, presumably, in due course, the Audit, Reporting and Governance Authority) should assess board performance review practice and reporting in the listed sector as part of its regular monitoring of the UK Corporate Governance Code.
Separately, the Institute has published proposed drafts of the new Code of Practice for board reviewers, Principles of Good Practice for listed companies and Guidance on Reporting on Board Performance Reviews under the UK Corporate Governance Code.
Also this week…
- AIM extends deadlines for financial reports. The London Stock Exchange AIM Regulation team has confirmed that the temporary relaxation for AIM companies to publish their annual and half-yearly reports has been extended until further notice of an orderly transition back to standard reporting periods. Under the temporary measures, an AIM company can extend by one month the period for publishing its half-yearly report by making an announcement via an RIS and informing AIM Regulation through its nominated adviser, and by three months the period for publishing its annual financial report by application to AIM Regulation under a specific procedure.
- FCA, FRC and PRA remind issuers of extended financial report deadlines. The Financial Conduct Authority (FCA), Financial Reporting Council (FRC) and Prudential Regulation Authority (PRA) have issued a joint statement reminding listed companies of the temporary measures in place which allow them an additional two months to publish their audited annual financial reports. The statement also reminds companies of the need for prompt disclosure under the Market Abuse Regulation and of the cumulative guidance issued by the FRC in relation to the ongoing Covid-19 pandemic.
- AIC to publish investment company ESG disclosures. The Association of Investment Companies (AIC) has announced that it will be launching new individual investment company environmental, social and governance (ESG) disclosures on its website. Member investment companies will be able to share their ESG policies in an easy, accessible way for investors, including whether they have signed up to sustainability initiatives, such as the UNPRI. The disclosures will be available on member companies’ profile pages in the Q2 2021.
- Glass Lewis publishes Covid-19 executive remuneration guidance. Glass Lewis has published new guidance on executive compensation during the on-going Covid-19 pandemic. The guidance notes that the pandemic has not affected Glass Lewis’ approach to executive pay, but that the shifting landscape means that the application of its policy approach may be affected. The guidance is intended to address this.
- Companies House legacy services to stay open for now. In our previous Corporate Law Update, we noted that Companies House had announced it intended to close its Companies House Direct (CHD) and WebCHeck services by February 2021. Companies House has now decided to defer these closures to ensure a smooth transition for its customers.
- Companies House pauses striking-off services. Companies House has announced that it is pausing its voluntary and compulsory striking-off processes until 21 February 2021. Companies House will continue to publish first notices for voluntary strike-offs. However, it will not be publishing first notices for compulsory strike-offs, nor second notices (the notice that finalises the striking-off) for either voluntary or compulsory strike-offs.