Corporate Law Update

• The Law Society publishes a new set of Q&A on electronic signatures
• A management charge payable by a subsidiary to its holding company was in fact a disguised distribution
• The FCA publishes an indicative list of instruments that need to be notified under DTR 5
• The FCA publishes a series of equivalence determinations for notifications by non-UK issuers
• The Takeover Panel publishes a revised version of the Takeover Code
• The London Stock Exchange publishes updated rulebooks
• The Government publishes new Brexit accounting guidance for companies
• The FRC publishes guidance for companies preparing IAS accounts following the end of the UK/EU transition period
• The website for the new UK Endorsement Board has been launched

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.

Law Society publishes Q&A on electronic signatures

The Law Society of England and Wales has published a new Q&A document on how to use electronic signatures and complete virtual executions.

The Q&A supplement the Law Society’s existing practice notes on executing documents by virtual means (so-called “Mercury signings”) and on executing a document using an electronic signature.

The purpose of the Q&A is to assist lawyers with some of the practicalities of using an electronic signature in England and Wales, including in a Mercury-compliant manner. However, it will also be of use to other persons who are responsible for arranging the signature and execution of contracts and other instruments.

The Q&A represents the views of the Law Society’s Company Law Committee as to general practice in commercial and contract law. It does not address the making of statutory declarations, wills or other documents that have formality requirements which mean that electronic signing is not possible.

Topics covered by the Q&A include how a signature to a document can be witnessed and how an electronic signature can be applied.

Service charge by holding company was an unlawful distribution

The High Court has held that a company made an unlawful distribution to its holding company when it agreed to pay for services already provided by the holding company.

What happened?

SSF Realisations Ltd (in liquidation) v Loch Fyne Oysters Ltd [2020] EWHC 3521 (Ch) concerned a company that carried on the business of supplying fresh, frozen and live fish.

SSF Realisations Ltd (the Company) was wholly owned by another company (LFO), which also operated in the wholesale and retail seafood business.

Over the years, an inter-company balance built up between the Company and LFO, with LFO owing the Company just under £1 million as at October 2011, representing principally the cost of supplies which the Company had made directly to LFO’s customers.

Moreover, by 2011, both the Company and LFO were in financial difficulty. A proposal was formulated to rescue LFO. However, that proposal required LFO first to sell the Company on terms that LFO would no longer owe any monies to the Company.

To achieve this, the Company’s directors called a board meeting to take two steps to reduce the debt owed by LFO to the Company, namely that the Company would:

• pay an interim cash dividend to LFO; and
• assume a management charge to be paid to LFO.

The matters were approved and, some weeks later, an interim dividend of £500,000 and a management charge of £330,000 were entered into the Company’s accounts. As a result of the interim dividend and the management charge, the Company became insolvent.

The restructuring proposal ultimately failed. The Company continued to trade for several years but it never returned to solvency. In June 2016, the Company was placed into administration and, in November 2016, it entered into liquidation.

In October 2017, the Company, acting through its joint liquidators, brought legal proceedings against LFO and the Company’s directors. They claimed that:

• the management charge was not genuine and was, in fact, a disguised distribution by the Company to LFO;
• when the amount of the management charge was combined with the amount of the interim cash dividend, the Company did not have sufficient profits to make the distribution; and
• LFO and the Company’s directors were therefore required to repay the unlawful distribution and compensate the Company.

What did the court say?

The court agreed with the liquidators.

Based on historic documentation, the judge was satisfied that the purpose of the interim dividend and the proposed management charge was to create an amount that could be set off against the sums owed by LFO to the Company, so reducing LFO’s debt to the Company.

A key question was whether the management charge was a genuine charge for services rendered by LFO, or whether it was, in fact, nothing more than a cash distribution or dividend.

The judge acknowledged previous case law (including the well-known cases of Aveling Barford Ltd v Perion Ltd [1989] BCLC 626 and Progress Property Company Ltd v Moorgath Group Ltd [2010] UKSC 55), which establishes that whether a transaction amounts to a distribution is a question of substance, rather than form.

With that in mind, he noted that, prior to November 2011, LFO had never imposed a management charge on the Company for any services it had provided. The first mention of the charge had been in November 2011 as part of a means to reduce LFO’s debt to the Company.

LFO and the Company’s directors did not dispute that a purpose of the management charge was to reduce LFO’s liabilities to the Company. But they claimed that the charge was proper, because it covered costs actually incurred by LFO which it was fair to recharge to the Company. These included seconding employees, providing transport services and supplying discounted products to the Company.

However, the judge, referring to previous case law (Heis v MF Global UK Services Ltd [2016] EWCA Civ 569), noted that a group company is not automatically required to reimburse another group company for services provided. A recharge will arise only if the companies enter into a contract that provides for that recharge.

In this case, the judge concluded that there had been no contract. This was underscored by the fact that the Company’s accounts had made no provision for any recharge costs to be paid to LFO. It also accorded with commercial reality: a holding company might choose to support a subsidiary by contributing capital or providing benefits in kind in the expectation the value of its investment will rise.

Because the Company was under no obligation to reimburse LFO, the decision to do so was voluntary and so amounted to a distribution to LFO.

Having decided this, the judge also concluded that, on the facts, the total amount of the distribution (the cash dividend and the management charge) exceeded the Company’s distributable profits and was unlawful to the extent of the difference.

He also decided that LFO was required to repay the distribution, and that two of the Company’s directors were in breach of duty and liable to compensate the Company for the unlawful portion of the distribution. (He decided that a third director of the Company, whilst also in breach of duty, ought reasonably to be excused from liability).

What does this mean for me?

The judgment highlights two key points for company directors.

The first is the importance of thoroughly scrutinising every payment, disposal or transfer of value by a company to its holding company – or, indeed, to any shareholder – and assessing whether that transaction is, in reality, a distribution and, if it is, whether the company has sufficient profits to make that distribution. Questions directors should ask themselves include:

• What is the company getting in return? The essence of a distribution is that the company is parting with something of value without receiving proper value back from its shareholder. If the company is getting nothing in return, or if the transaction is at am undervalue, some or all of the transaction will almost inevitably be a distribution.
• Is there a legal obligation to make the transfer? Paying properly incurred legal debts, whether under a formal loan arrangement or some other contractual promise of reimbursement, is unlikely to amount to a distribution. But where there is no obligation to make the transfer, it is much more likely to be characterised as a voluntary distribution.
• If the company is proposing to sell an asset to a shareholder, holding company or sister company, is the shareholder paying full value? If the buyer pays the market value of the asset, there is no distribution. If it pays book value, under section 845 of the Companies Act 2006, the company will normally need distributable profits of at least a penny.
• In case it is found to be a distribution, does the company have sufficient distributable profits to carry out the transaction? The consequences of making an unlawful distribution can be severe and can result in personal liability for directors. The position can become more serious still if the company subsequently becomes insolvent.

Secondly, company directors should consider carefully whether and to what extent to document any intra-group arrangements between different group companies. There is sometimes an assumption that, where one group company supplies benefits to, or incurs costs on behalf, of another group company, it is entitled to reimbursement. This will be the case only if there is an enforceable legal arrangement in place.

FCA publishes list of instruments subject to DTR 5

The Financial Conduct Authority (FCA) has published an indicative list of derivatives and non-equity financial instruments that are subject to the notification requirements in Chapter 5 of its Disclosure Guidance and Transparency Rules Sourcebook (DTR 5).

The notification requirements in DTR 5 apply to an issuer whose securities are admitted to trading on a UK regulated market (such as the London Stock Exchange Main Market) or a so-called “prescribed market” (such as AIM).

Under DTR 5.1.2R, generally speaking, a person must notify an issuer if the percentage of voting rights they hold in the issuer reaches, exceeds or falls below 3% or any whole percentage point above 3%.

DTR 5.3.1R(1) extends this notification obligation to direct and indirect holdings of financial instruments that are deemed to give someone voting rights in an issuer. Generally, these are instruments that give their holder a right (on maturity) to acquire voting shares in the issuer, or which have a similar economic effect and are referenced to voting shares in the issuer.

The notification requirements derive ultimately from the European Union Transparency Directive. The European Securities and Markets Authority (ESMA) has previously published an indicative list of instruments that need to be notified under the Directive (and, so, under DTR 5).

At 11:00 p.m. UK time on 31 December 2020, EU law ceased to apply directly in the UK, along with the status of any ESMA guidance in the UK. As a result, the FCA was tasked with producing a replacement indicative list to replace the list previously published by ESMA.

The list published by the FCA is effectively identical to the previous list published by ESMA, preserving the regime for the time being in UK law. For clarity, the list confirms that the requirement to notify an issuer applies to holdings of:

• transferable securities, options, futures, swaps, forward rate agreements, contracts for difference and other contracts with similar economic effects that may be settled physically or in cash; and
• (provided they reference voting shares in the issuer) certain convertible and exchangeable bonds, certain instruments referenced to an index or basket of shares, warrants, repurchase agreements, rights to recall lent shares, contractual pre-emption rights, hybrid and combination financial instruments, certain other conditional contracts, and certain shareholders’ agreements.

FCA publishes equivalence determinations for financial statements

The Financial Conduct Authority (FCA) has announced a series of equivalence determinations for non-UK regimes for the purposes of financial reporting by publicly traded companies, following the end of the UK/EU transition period at 11:00 p.m. on 31 December 2020.

The determinations apply to issuers whose securities are admitted to trading on a UK regulated market but whose registered office is located outside the UK.

The effect of the equivalence determinations is that issuers which prepare their financial statements under certain non-UK accounting regimes are exempt from some or all of the requirements in Chapter 4 of the FCA’s Disclosure Guidance and Transparency Rules (DTR 4) to prepare their financial statements under UK accounting principles.

Consolidated financial statements

DTR 4.1.6R(1) requires issuers to prepare their consolidated financial statements and parent company accounts using UK-adopted IFRS. Similarly, DTR 4.2.4R(1) requires the condensed set of accounts in the issuer’s half-yearly report to be prepared using IAS 34 as adopted by the UK.

The FCA has decided that an issuer can continue to draw these particular financial statements up using EU-adopted IFRS, IFRS adopted by the International Accounting Standards Board (IASB), or generally accepted accounting principles in the United States, Canada, the People’s Republic of China, Japan or South Korea.

Timing and contents of financial statements

DTR 4.1 and 4.2 set out the content requirements for an issuer’s half-yearly and annual financial reports, as well as when they must be published and for how long they must be made available.

The FCA has decided that an issuer will not be subject to these requirements if it is subject to:

• the periodic disclosure requirements in Section 13(a) of Securities Exchange Act of 1934 and the rules governing financial reporting for issuers of securities in the United States; or
• the periodic disclosure requirements in Canadian National Instruments NI 52-107 and NI 52-109 and the rules governing financial reporting for issuers of securities in Canada.

In addition, issuers that are incorporated in Switzerland will be exempt from various selected provisions (but not all) of DTR 4.1 and 4.2.

Major shareholding notifications

DTR 5.5.1R and 5.6.1R require issuers to notify the market of certain changes to their capital structure, and DTR 5.8.12(1) requires non-UK issuers to notify the market of any changes to any substantial holdings of their shares notified under DTR 5.1.2R (see the previous item in this update).

The FCA has decided that the notification regimes in the United States, Japan, Israel and Switzerland are equivalent and so issuers incorporated in any of these jurisdictions are exempt from these DTR.

Other exemptions for Switzerland

Finally, the FCA has decided that issuers incorporated in Switzerland are exempt from certain information requirements in DTR 6.

Also this week…

• Takeover Panel publishes revised Takeover Code. The Takeover Panel has confirmed that it has published a revised version of its Takeover Code, effective from 11:00 p.m. on 31 December 2020. The revised Code reflects previous amendments made prospectively in relation to the UK’s withdrawal from the European Union and document charges, as well as other minor amendments.
• LSE publishes revised rulebooks. Following the end of the UK/EU transition period at 11:00 p.m. on 31 December 2020, the London Stock Exchange has published clean versions of its updated rulebooks, including its Admission and Disclosure Standards, its AIM Rules for Companies and its AIM Rules for Nominated Advisers.
• Government publishes Brexit accounting guidance. The Government has published guidance for UK companies on accounts and audit following the end of the UK/EU transition period. The guidance covers preparing accounts, the requirement to constitute an audit committee, and appointing auditors.
• FRC publishes guidance on IAS accounting following Brexit. The Financial Reporting Council (FRC) has published guidance for companies that will be preparing accounts using International Accounting Standards (IAS) for a period that straddles 11:00 p.m. on 31 December 2020. The guidance confirms that these companies must prepare this set of accounts using EU-adopted International Financial Reporting Standards (IFRS) but should, for future accounts, use UK-adopted IFRS.
• UK Endorsement Board website launched. A website has been launched for the new UK Endorsement Board. The purpose of the Board is to endorse and adopt new and amended international accounting standards for use by UK companies, following the UK’s withdrawal from the European Union.