Corporate Law Update

• A rights issue deliberately designed to dilute a minority shareholder did not amount to unfair prejudice
• The FRC publishes a draft annual report taxonomy suite for 2023
• The FRC also publishes a report and snapshot of current practice in UK audit reporting
• The LSE publishes its Dividend Procedure Timetable for 2023

Share issue designed to dilute minority shareholder was not unfair prejudice

The High Court has held that a shareholder in a company was unable to claim relief for unfair prejudice when the company conducted a share issue that diluted the shareholder’s holding by more than half.

What happened?

Isaac v Tan and another [2022] EWHC 2023 (Ch) concerned the holding company (the Company) of a company that operated a professional football club competing, at the time, in the English Football League Championship (the Club).

Following a series of acquisitions between 2010 and 2013, one individual (VT) came to hold around 94.22% of the Company’s shares. VT had also acquired the right to repayment of a considerable amount of debt owed by the Club.

The rest of the Company’s shares were held by minority shareholders, including one individual (MI) who was also a director of the Company and who, at VT’s request, retained a 3.97% shareholding in it.

In 2015, relations between VT and MI became worse, culminating in a series of legal disputes and proceedings between them.

MI offered to sell his shares to VT at the price VT had previously paid when buying out other minority shareholders, but VT declined the offer. Instead, VT moved a shareholder resolution to remove MI as a director of the Company.

In January 2016, a transfer embargo was imposed on the Club as a result of its financial position. In response, VT pledged to convert significant amounts of the debt owed to him into equity in the Company to improve the Club’s position.

VT then proposed various possible arrangements, all of which were intended to dilute MI’s shareholding down to an insignificant level.

Ultimately, the Company’s board resolved to carry out a rights issue under which each shareholder would have the right to subscribe for five new shares for every two shares they already held. VT would pay for his new shares by writing off around £68 million of the debt owed to him by the Club.

Under the terms of the rights issue, MI would have needed to pay £2.8m for the new shares to maintain his shareholding of 3.97%. In VT’s view, MI was unlikely to be willing to take up his entitlement under the rights issue.

In the event, VT was right. The rights issue took place and MI did not take up his entitlement. His holding was consequently diluted from 3.97% down to 1.18%.

MI then petitioned the court for relief in unfair prejudice. He argued that the rights issue had not been carried out for a proper business purpose, but rather because of VT’s personal animosity towards him. He alleged that VT had used the corporate structure of the Club to further his own agenda and, as a result, the Company’s affairs had been conducted in a manner that was unfairly prejudicial to MI.

MI also claimed that, by “rubber-stamping” VT’s proposals, the Company’s directors had breached their duties to exercise independent judgment and not to allot shares for an improper purpose.

What did the court say?

The court said there had been no unfair prejudice.

VT’s actions had not amounted to conduct of the Company’s affairs. VT had never been a director and so had never assumed any direct control of the Company or the Club. He had merely used the “normal levers” available to a majority shareholder to exert influence.

There was nothing legally unfair about the arrangements to dilute MI. The conduct might have been “morally” unfair, but VT was entitled to consider his interests as a shareholder in the Company and a creditor of the Club above all others.

The directors had not breached their duty to exercise independent judgment. The directors had clearly engaged with the proposals and there was a commercial rationale for the rights issue.

The judge noted that a desire to reduce the Club’s substantial burden of debt was a significant motivation and that allotting shares to achieve that was a proper purpose.

However, one of the directors, when approving the rights issue, had also had in mind the significant benefit for VT, which was not proper. He had therefore breached his duty to exercise his powers for a proper purpose, and this had been unfair to MI.

However, although those actions had been unfair, they had not actually caused MI any prejudice. The rights issue was nonetheless supported by proper purposes and would have taken place anyway.

As a result, the court dismissed MI’s petition.

What does this mean for me?

As we saw last week, unfair prejudice cases are highly fact-specific. Behaviour that might give rise to a right to seek relief in one set of circumstances may not do so in another.

This judgment highlights two key points. First, it is essential when petitioning for relief to demonstrate that the company’s affairs have been conducted unfairly in some way. Clashes between shareholders, who are entitled to have sole regard to their own economic interests, are common and the court will not allow an unfair prejudice petition to be used to mediate shareholder disputes.

Second, there must be some form of prejudice. It is not enough that there has been some unfair behaviour or malign motivation. The person seeking relief must show that they have suffered some effect of that behaviour that they would not otherwise have had to endure.

A person considering petitioning relief for unfair prejudice should ask themselves three questions.

• Has there been some unfair behaviour? This could include breaching the company’s constitution, breach of directors’ duties or, in some cases, acting contrary to a mutual understanding between the shareholders.
• Did that behaviour amount to conduct of the company’s affairs? Mere squabbles between shareholders will not form the basis of unfair prejudice.
• Has the petitioner been in any way prejudiced by that behaviour? If the loss or adverse effect to the shareholder would have happened anyway, it will be difficult to convince the court.

FRC consults on draft 2023 taxonomy suite

The Financial Reporting Council (FRC) has published its draft 2023 taxonomy suite and is asking for comments from the public.

Under Rule 4 of the Financial Conduct Authority’s Disclosure Guidance and Transparency Rules (the DTR), an issuer with securities admitted to trading on a UK regulated market (such as the London Stock Exchange Main Market or the AQSE Main Market) must publish an annual financial report within four months of its financial year-end.

Under DTR 4.1.14R, an issuer must prepare its annual financial report using the single electronic reporting format, more commonly known in the UK as “UKSEF”. In particular, an issuer must mark up parts of its report in iXBRL format using an acceptable taxonomy.

For financial years beginning on or after 1 January 2022, issuers must currently use the UKSEF 2022 version 2 taxonomy.

Other entities can adopt the taxonomy on a voluntary basis if they wish to do so. However, companies that need to file accounts with their company tax return must submit those accounts in iXBRL format.

For users of annual reports, a key benefit of the taxonomy is that using iXBRL allows financial and non-financial data that has been “tagged” to be extracted and manipulated with greater ease.

Among other things, the FRC has:

• updated tags and guidance for interim reporting, medium-sized companies and “filleted” accounts;
• added support for alternative performance measures (APMs); and
• added proposals for diversity and inclusion (D&I) reporting, following new rules introduced by the FCA (see our previous Corporate Law Update).

The FRC intends to publish the final 2023 taxonomy suite in October 2022. It is intended to take effect for financial years beginning on or after 1 January 2023.

The draft suite is open for comments for a period of two months from 12 August 2022.

FRC publishes report and snapshots of current practice in UK auditor reporting

The FRC has published a report and six infographic snapshots showing current practice in auditor reporting in the UK. The purpose of the report and snapshots is to start a dialogue with stakeholders on how auditor’s reports can be further improved. The FRC highlight the concern that, after an initial burst of innovation, following their introduction in 2014, auditor’s reports (“Reports”) have become too long and contain too many boilerplate disclosures.

The research was undertaken by teams based at the Universities of Portsmouth, Southampton and Brunel. They analysed 396 Reports issued by FTSE 350 companies and large AIM companies during the period between October 2021 and June 2022.

The resulting analysis is presented in a visual format in the snapshots, which cover the following themes:

• Understandability and useability of auditor's reports. This looks at how the length of Reports varies between firms and sectors. It applies objective measures such as readability scores and measurement of standardised or generic language. Findings include that:
  • Narrative disclosures are the key channel for the communication of specific findings.
  • The length of each Report depends on company size and sector, with the longest Reports being for banks and energy companies.
  • Shorter Reports consistently contained more boilerplate than longer Reports.
• Communicating judgments on materiality and the scope of group audits. This considers how auditors have set out the basis of judgments and decisions on materiality, scoping and coverage. Findings include that:
  • Adjusted profit measures remain the most common benchmark for the determination of materiality, although these have become less common.
  • Most Reports described the professional judgments made by the auditor for the selection of materiality.
  • Reports frequently included information on the determination of which components were in scope for additional audit procedures.
• Key audit matters. This includes a review of the number of Key Audit Matters (KAMs) in Reports and the most common types of risks of material misstatement. Findings include that:
  • The number of KAMs varies between companies, with a reduction in the average number since reporting on KAMs was introduced.
  • Types of KAM have generally not varied since they were introduced.
• Climate change, Covid-19, alternative performance measures and graduated findings. This reviews how KAMs in Reports have addressed certain types of risk. Findings include that:
  • Climate change risks were rarely reported as KAMs.
  • Responses to COVID-19 risks were dealt with inconsistently.
  • KAMs on alternative performance measures are extremely rare, as is the use of graduated findings - conclusions are generally expressed as simple, formulaic approaches.
• Going concern. This considers how auditors approach the use of the going concern assumption in financial statements. Findings include that:
  • KAMs on going concern were the main channel for reporting heightened risks in this area and these were more commonly issued for FTSE 250 and large AIM companies, and for economic sectors most heavily affected by the Covid-19 pandemic.
• Fraud and other irregularities. This looks at auditors’ responses to the new requirement to explain the extent to which the audit is designed to detect fraud and other irregularities. Findings include that:
  • Auditors used a range of approach to explain the extent to which the audit was considered capable of detecting irregularities.
  • Reports issued for FTSE 100 companies and by “Big 4” audit firms included the longest disclosures, with the least boilerplate.
  • Responses to fraud risks tend to be generic and untailored.

LSE publishes Dividend Procedure Timetable for 2023

The London Stock Exchange has published its annual Dividend Procedure Timetable for 2023 (the Timetable). The Timetable provides a guide for Main Market and AIM companies when formulating their programmes for interim and final dividends.

The Timetable sets out a series of ex-dividend dates with their corresponding record dates and the latest date on which the dividend may be announced. It also specifies certain content requirements for an issuer’s dividend announcement.

Companies that adhere to the Timetable do not need to notify the Exchange of their programme in advance. However, dividends that fall outside the parameters set out in the Timetable must be discussed and agreed in advance with the Exchange.