Corporate Law Update
- The court analyses the extent of liability of a beneficial owner of shares who was not named in the share sale agreement
- The FCA adopts a modified form of the ESMA guidelines on prospectus disclosures
- The Government sets out the next steps in its programme of corporate governance and audit reform
- The extended Dormant Assets Scheme launches
The court has analysed the extent to which the beneficial owner of shares who was not named in a share sale and purchase agreement (SPA) was liable to the buyer for breach of warranty and misrepresentation.
Ivy Technology Ltd v Martin and another  EWHC 1218 (Comm) concerned the sale of shares in an online gambling business by two individuals to a trade buyer.
Mr Martin and Mr Bell were each the beneficial owner of 50% of the sale shares.
However, the SPA (incorrectly) stated that Mr Martin was the beneficial owner of 100% of the sale shares and that no other person had any right or interest in them. Mr Martin was made a party to the SPA, but Mr Bell was not.
Following the sale, the buyer brought claims against Mr Martin and Mr Bell relating to statements they had made regarding the profitability of the underlying business. Those claims fell into three categories:
- Alleged misrepresentations made by both Mr Martin and Mr Bell at a meeting in Prague near the beginning of negotiations with the buyer.
- Alleged misrepresentations made by Mr Martin alone during the course of negotiations. The buyer argued that Mr Martin had made these misrepresentations both on his own behalf and as Mr Bell’s agent.
- Breaches of warranty in the SPA. Again, the buyer argued that Mr Martin had given those warranties both on his own behalf and as Mr Bell’s agent.
The court ultimately found that the statements made to the buyer had in fact been false and so amounted to misrepresentations or breaches of warranty (as applicable).
The key question of interest was whether Mr Bell was liable to the buyer for the misrepresentations or the breaches of warranty.
Mr Bell denied that Mr Martin had any authority to represent him and so make the statements on his behalf. He also argued that he should not be liable for any breaches of warranty, as he had never been a party to the SPA and his liability under the SPA had been expressly excluded by a clause that excluded the rights of anyone other than the named parties (a third-party rights clause).
What did the court say about the alleged misrepresentations?
The judge found that Mr Martin and Mr Bell both made fraudulent misrepresentations at the meeting in Prague. They both knew the statements they had made were false. They had made them to “offload … a failed business” onto the buyer.
The court also found that Mr Martin had made fraudulent misrepresentations during negotiations and that, in doing so, had also made those misrepresentations on behalf of Mr Bell. As a result, although Mr Martin alone made those statements, both he and Mr Bell were liable to the buyer.
Mr Bell had argued that he should not be liable for the fraudulent misrepresentations Mr Martin alone made, because Mr Martin was not authorised to make statements on behalf of Mr Bell that were fraudulent. If he did so, he was acting outside the scope of his agency.
The judge disagreed. He noted that the relevant question is whether the agent was authorised to negotiate in relation to the transaction in question. If the agent is authorised, statements the agent makes in relation to that transaction can be attributed to the agent’s principal.
What did the court say about the alleged breach of warranty?
Separately, the judge found that Mr Martin had committed breaches of warranties in the SPA. However, he concluded that he had not given those warranties as Mr Bell’s agent and, consequently, Mr Bell was not liable for breach of warranty.
The buyer advanced powerful arguments why Mr Martin was acting as Mr Bell’s agent, such that Mr Bell should be regarded as a party to the SPA. These included that Mr Bell would need to be a party to the SPA to transfer his shares to the buyer. This all suggested that Mr Martin was negotiating on behalf of Mr Bell (in respect of Mr Bell’s shares) as his agent.
The judge found that the buyer was well aware that Mr Bell owned 50% of the shares. If the SPA had simply failed to mention Mr Bell, the court might have concluded that Mr Bell was a “disclosed and identified principal” and so a party to the SPA (meaning that Mr Bell would also have given the incorrect warranties).
However, the judge found that it was clear from the terms of the SPA that Mr Bell was not a party. The SPA specifically named Mr Martin as the 100% owner of the shares and confirmed that no-one else had any interest in them. This was reinforced by the third-party rights provision.
The judge acknowledged that this conclusion did not sit easily with the fact that the buyer knew that Mr Bell owned 50% of the shares. However, the judge was “driven to the conclusion” that the buyer was willing to contract with Mr Martin alone on the basis that Mr Martin and Mr Bell would sort out the beneficial ownership of the shares between them.
What does this mean for me?
Above all, this case shows the need for clear and careful drafting and transaction-structuring.
If a party to a transaction is to undertake obligations (for example, by giving warranties or entering into restrictive covenants) and bear any potential liability that comes with contravening those obligations, it is important to join them into the transaction documentation or to make it clear that some other person is signing for them as their agent.
There may be good reason why a transaction party does not wish to be named as a signatory to the transaction documentation. However, in that case, it is important to ensure that any pre-transaction structuring (such as the transfer of securities or other property) has been completed and that the post-structuring position is properly reflected in the main transaction documentation.
Conversely, a person who elects to remain “behind the scenes” and not to enter into any formal transaction documentation should not assume that they are escaping any potential liability. The courts will look at the totality of a transaction and the role each party has assumed. In this case, the court was prepared to find that misrepresentations had been made well before the SPA was signed.
The Financial Conduct Authority (FCA) has published Handbook Notice 99, in which it has confirmed it is implementing the changes proposed in Quarterly Consultation No. 33, published in September 2021.
The changes involve minor amendments to the Prospectus Regulation Rules and Listing Rules to reflect the FCA’s proposals in Primary Market Bulletin 34 (PMB 34) to adopt the European Securities and Markets Authority (ESMA) prospectus disclosure guidelines (the ESMA Guidelines) in the UK, subject to some modifications.
The FCA has also published Primary Market Bulletin 40, setting out the changes it is making to technical notes within its Knowledge Base in order to onshore the ESMA Guidelines. The FCA is making a few changes to the guidelines proposed in PMB 34 but, in the main, is adopting the guidelines as proposed.
For more information on those proposals, see our previous Corporate Law Update.
The changes, made through an implementing instrument, came into effect on 27 May 2022.
The UK Government has published the official response to its March 2021 consultation on corporate governance and audit. For more information on that consultation, see our previous Corporate Law Update.
The response sets out reforms the Government intends to introduce in response to the consultation in order to build trust in the UK’s audit, corporate reporting and corporate governance system and to increase resilience and choice in the statutory audit market.
Many of the reforms are predicated on the creation of the new regulator – the Audit, Reporting and Governance Authority (ARGA) – which will replace the Financial Reporting Council (FRC) as the body responsible for overseeing corporate reporting and governance and statutory audit.
The main reforms are set out below.
- Expanding the scope of “public interest entities” (or PIEs). The Government has decided to expand the concept of a PIE to private companies, companies admitted to multilateral trading facilities (MTFs) (such as AIM), limited liability partnerships (LLPs) and third-sector entities. These entities will become subject to more extensive reporting obligations (although they will not be automatically subject to the full gamut of audit requirements, such as audit tendering).
This will apply only to entities that have both annual turnover of £750m or more and 750 employees or more (which the Government has termed the “750:750 test”), whether at an individual or a group level. The Government will be able to amend the 750:750 test in the future by changing the thresholds or by introducing specific tests to include or exclude certain kinds of entity.
- Directors will need to take greater responsibility for a company’s internal control systems. The Government will invite the FRC/ARGA to amend the UK Corporate Governance Code (the UKCGC) to require an explicit statement by a company’s directors about the effectiveness of its internal controls. This will affect premium-listed companies and any entities that apply the UKCGC voluntarily.
The Government will not require more formal assurance on internal controls from a company’s auditors. However, 750:750 PIEs will be required to confirm in their audit and assurance policy (see below) whether they plan to seek external assurance of their internal controls reporting.
The Government and ARGA will assess in due course how effective the changes to the UKCGC have been and, if they fall short of the Government’s desired outcomes, consider introducing statutory duties using powers in the Companies Act 2006.
The Government will also require directors of 750:750 PIEs to report on steps they have taken to prevent and detect fraud. The response provides little detail on what precisely this statement would contain, but it does note that the statement would be subject to review by the company’s auditors.
- Directors will face additional sanctions if they fail to meet their audit and reporting duties. ARGA will have new powers to investigate and sanction directors (both executive and non-executive) and equivalent managers of PIEs for breaches of their corporate reporting and audit-related duties and responsibilities by taking “civil regulatory action”. This would follow similar principles to the FRC’s existing audit enforcement regime. These new powers would complement, rather than replace, existing powers to sanction directors under legislation and FCA rules.
The response clarifies that the purpose of the new enforcement powers is not to judge a company’s directors against its financial position, but rather against the duties they owe to the company and its stakeholders.
Finally, the Government will invite the FRC/ARGA to consult on changing the UKCGC to provide greater transparency about malus and clawback arrangements for directors. The intention is to encourage a broader range of conditions in which remuneration could be withheld or recovered beyond “gross misconduct” or “material misstatements”, with the UKCGC possibly providing an illustrative set of conditions.
- There will be a new “resilience statement”. 750:750 PIEs will need to publish a new “resilience statement”, setting out matters the directors consider represent a “material challenge to resilience” over the short, medium and long terms. The short-term section will cover material uncertainties uncovered by the going-concern exercise and replace a company’s going concern statement.
The medium-term section will effectively replicate the viability statement. The Government has decided not to proceed with a mandatory period of five years for the medium term, giving PIEs flexibility to decide a period for themselves. However, it will require “reverse stress-testing”, with PIEs needing to include at least one stress test in their resilience statement.
- Audit and assurance policy. 750:750 PIEs will need to publish an audit and assurance policy every three years alongside their audit committee report, setting out internal auditing and assurance process and their policy towards tendering external audit services. The policy will not (as originally proposed) be subject to a shareholder vote, but entities will need to state how they have taken account of shareholder views in developing the policy. Entities will also need to publish an annual “implementation report”, explaining how their policy is working in practice.
- More narrative around dividends. 750:750 PIEs will be required to disclose their distributable reserves in their financial statements. (For groups, this would apply only to the parent undertaking.) ARGA will be tasked with publishing guidance on what should be treated as “realised” profits and losses for this purpose.
Directors of PIEs will also be required to explain the board’s long-term approach to the amount and timing of shareholder returns, as well as explicitly confirm the “legality” of proposed dividends and any dividends paid in-year. The Government will not, however, be proceeding with a requirement to confirm that a dividend would not jeopardise the company’s solvency over two years.
- The role of ARGA. The role of the new regulator, ARGA, will be centred around PIEs. The Government has acknowledged this creates an open question over whether ARGA should continue the FRC’s current responsibility of overseeing companies admitted to AIM or another MTF that will not become PIEs under the changes. It intends to consult with the FRC, the Financial Conduct Authority (FCA) and the London Stock Exchange on this.
ARGA will have new powers to direct changes to accounts and reports without a court order. Also, whereas the FRC is currently able to review only the “auditable parts” of an entity’s annual report, ARGA will have power to review the entirety of the report (including, for example, an entity’s corporate governance statement, its director’s remuneration report and any committee reports).
- Changes for auditors and audit committees. ARGA will have power to impose additional requirements on the audit committees of FTSE 350 companies in relation to appointing and overseeing the company’s external auditor. This may include provisions that encourage shareholder engagement with a company’s audit plan (see above).
The Government also intends to proceed with its proposal (in line with the recent Brydon Review) that an auditor who ceases to hold office at a particular company provide more information on the reasons for their departure.
- There will be “shared audits” for the biggest companies. Challenger audit firms will gain the opportunity to audit a “meaningful proportion” of subsidiary audits conducted for FTSE 350 companies. ARGA will have the power to set thresholds to determine what amounts to a “meaningful proportion” for these purposes.
The Government has decided not to introduce a market share capital regime, under which a proportion of audits below a certain market share capital would need to be reserved to challenger firms. However, it has said it will reconsider this if choice within the FTSE 350 does not improve.
The response also sets out next steps for regulation of the audit profession, including the separation of audit and non-audit services, which will be of interest to audit and accountancy firms.
Certain measures in the response, including the creation of ARGA, will require primary legislation. The Government intends to legislate when Parliamentary time allows.
Other measures, such as changes to the UK Corporate Governance Code, will not require primary legislation, and some measures may result in changes to rules and regulations issued by other authorities. We expect the relevant authorities to consult on these in due course.
The legislation extending the UK’s Dormant Assets Scheme came into force on 6 June 2022.
To date, the Scheme has allowed participating banks and building societies to apply monies in long-dormant bank accounts towards charitable purposes.
The Dormant Assets Act 2022 expands the Scheme to other classes of investment, including listed securities. For more information on the expanded Scheme, see our previous Corporate Law Update.
Macfarlanes is proud to have assisted the Government on the expansion of the Scheme.