Transacting with directors – it pays to take care

What happened?

MetalNRG plc v BritENERGY Holdings LLP and others [2022] EWHC 2528 (Ch) concerned a company (MetalNRG) that carries on business as a natural resources investment company.

In November 2019, MertalNRG appointed Mr Pierpaolo Rocco as a director of its board and its executive director for Oil and Gas.

In March 2020, Mr Rocco identified a potential investment opportunity. The parties decided that the investment would be funded partly by MetalNRG and partly by a limited liability partnership (the LLP) owned by private investors, including Mr Rocco. The LLP was owned as to 70% by a company which was, in turn, wholly owned by Mr Rocco’s wife.

To this end, MetalNRG and the LLP incorporated a company (BritNRG) to act as their investment conduit. They constructed a detailed staged funding mechanism which, on completion of funding, would entitle MetalNRG and the LLP to 50% each of the shares in BritNRG.

In the event, MetalNRG failed to pay its third funding commitment due to a lack of immediately available funds. The result was that it was unable to acquire 50% of the shares in BritNRG.

To address this, in April 2021, MetalNRG and the LLP negotiated a suite of documents designed to ensure that MetalNRG acquired 50% of the shares in BritNRG. These included:

• a share sale and purchase agreement (the SPA) under which MetalNRG would acquire shares in BritNRG from the LLP and Mr Rocco; and
• an option agreement (the Option) under which, for an up-front fee, MetalNRG would have the right to acquire shares in BritNRG from the LLP at a later date at a fixed price.

Subsequently, MetalNRG sought to rescind the agreements, claiming that they were substantial property transactions between it and a person connected with one of its directors (Mr Rocco) that required the approval of MetalNRG’s shareholders under the Companies Act 2006. Because that approval had not been obtained, it claimed it was entitled to walk away from the arrangements.

The LLP claimed that the agreements did not amount to a substantial property transaction, giving various reasons.

The High Court was deciding whether to grant summary judgment to MetalNRG or to allow the claim to proceed to a full trial, and so much of the LLP’s arguments were detailed and revolved around whether there was sufficient evidence to decide in favour of MetalNRG.

However, in summary, the court had to decide the following questions:

• Does section 190 require shareholder approval only where there is a high degree of certainty that the acquisition will take place? In other words, if an arrangement is conditional and there is no certainty that the condition will be satisfied, is shareholder approval unnecessary?
• Does the grant of an option over shares create a non-cash asset in the form of a right to acquire shares or an interest in the shares themselves?
• When are two or more transactions part of the same overall arrangement?

What did the court say?

The LLP had argued that, based on previous case law, for an arrangement to fall within section 190 and, therefore, for shareholder approval to be required, there needed to be a “high degree of certainty” that it would happen.

Because the arrangements in this case were conditional and there was no high degree of certainty that the conditions would be fulfilled, the LLP claimed they did not need shareholder approval.

The court disagreed. In essence, it said that the need for a “high degree of certainty” applies before the company enters the arrangement in question. In other words, there needs to be a high degree of certainty that the company will in fact enter into the acquisition.

However, in this case, MetalNRG had entered into the acquisition arrangements. The fact that they were conditional was irrelevant. Otherwise, the perverse outcome could be that the need for shareholder approval could be effectively avoided merely by making an arrangement conditional. That made no sense, especially if the conditions were ultimately satisfied and the acquisition took place. It would “drive a coach and horses” through section 190.

The court also found that the grant of the Option created a right over shares. It created a contractual right for MetalNRG to acquire the shares in question and restricted the LLP from dealing with those shares while the Option existed. Because of this, the grant of the Option amounted to the acquisition of a non-cash asset.

Finally, and perhaps most interestingly, the court examined whether the SPA and the Option (as well as a second, separate option) amounted to a single arrangement. It found that they did for the following reasons.

• The parties had entered into both the SPA and the Option in the same context, namely MetalNRG’s inability to provide its final tranche of funding and to acquire 50% of BritNRG.
• It was an “inescapable conclusion” that the parties had entered into the SPA and the Option to address that problem.
• MetalNRG’s board reviewed and approved both the SPA and the Option at the same board meeting. The minutes of that meeting described the SPA and the Option as “revised arrangements” and noted that the SPA had to be conditional on the Options being signed.
• The SPA and the Option were executed on the same day.
• The SPA specifically stated that it and the Option (and the second option) comprised the “whole agreement between the parties”, suggesting that they were all part of a single arrangement.
• The SPA specifically required MetalNRG to provide evidence that its board had approved the execution of both the SPA and the Option.

What does this mean for me?

The decision in this case concerned an application for summary judgment. High Court cases do not set binding law in any event, but a decision on summary judgment is even less persuasive. However, the judgment is nonetheless a useful indication of the court’s thinking on this point.

It should come as no surprise that there is no need for a high degree of certainty that an acquisition will complete for it to fall within section 190. Any other interpretation of the legislation would severely deprive shareholders of the very protection that section intends to provide.

It is also not surprising that the court felt that the grant of the Option amounted to the acquisition of a non-cash asset, although it is always useful to receive more clarification on this point. Section 1163 is slightly clumsily drafted and can give rise to uncertainty.

An option arguably does not give any right over or interest in shares in the “pure sense”. The shares remain the property of the person granting the option. The optionholder will not have the right to vote the shares, receive dividends or sell them and take any sale proceeds. Their only right is to force a sale of the shares at some point in the future.

However, the court felt that the wording of sections 190 and 1163 should be interpreted deliberately widely. An option to acquire shares was enough of a “right over shares” to fall within those sections.

In our view, even if the court had reached the opposite conclusion, it seems quite clear that the grant of the Option also created new property in the form of a contractual right. (Under the law of England and Wales, contractual rights are regarded as a form of property in their own right.)

But it is the last element of the judgment that is most useful for companies, directors and advisers. The court’s reasons for finding that the two agreements amounted to a single arrangement can serve as useful guidance when understanding whether shareholder approval under section 190 is required (or was required for a historic transaction).

The consequences of failing to obtain shareholder approval when required can be severe. The company may be able to set the transaction aside, effectively nullifying it, and any director or person connected with a director may be required to compensate the company.

When a company approaches a proposed transaction that involves, or may involve, one or more of its directors, therefore, it is worth asking the following questions.

• Is the proposed transaction between the company and one of its directors? If the company is a subsidiary, does it involve a director of the subsidiary’s holding company?
• If not, is the proposed transaction with a person connected with such a director? This includes members of a director’s family and any companies controlled by the director and/or any other persons connected with the director.
• Does the transaction involve the transfer of any assets?
• If so, what is the value of those assets, both in absolute terms and as a percentage of the company’s asset value. (This will be measured by reference to the company’s last accounts.)
• What other transactions are the parties entering into? Are they in any way linked? If so, the parties will need to treat the transactions as a single arrangement and aggregate the value of all non-cash assets.

Finally, the company should consider whether any other restrictions on transacting with a director apply.

• A transaction between a company and one of its directors may be prohibited under the terms of a shareholders’ or investment agreement or the company’s articles of association without the consent of one or more specified persons.
• If the company is listed, the transaction will need to be notified and may also require shareholder approval under the Financial Conduct Authority’s Listing Rules, either as a transaction with a related party or (if the value of the asset is particularly high) as a class 1 transaction.
• If the company is admitted to trading on AIM, the transaction will need to be notified and the company may need to obtain a “fair and reasonable” opinion.