• The Treasury publishes the recommendations from Lord Hill’s review of the UK’s listing regime
• The High Court considers a challenge to an expert’s decision on a completion accounts exercise
• Restrictive covenants were not unenforceable restraints of trade
• The consent of an “ultimate beneficial owner” was sufficient to invoke the Duomatic principle
• ESMA’s new Q&A on prospectus disclosure requirements go live
• The ICAEW responds to the FRC’s proposal for a new “principles-based” reporting framework

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.

Results of UK listing regime review published

HM Treasury has published the final report of the UK Listing Review, chaired by Lord Hill.

The report follows a call for views, published by the Treasury in November 2020, on how to ensure the UK’s listing regime remains world-leading and fit for the future. For more information on that review, see our previous Corporate Law Update.

For our views on the report’s recommendations, see this article by our colleagues, Richard Burrows and Mark Slade. Meanwhile, the key recommendations arising out of the report are as follows.

1. The Government should publish a short annual report on the state of the City, setting out progress that has been made in improving the UK’s competitive position over the previous period.
2. The Financial Conduct Authority (FCA) should have a statutory duty to take into account the UK’s overall attractiveness as a place to do business. It should also commit more resource to engaging with companies that are coming to market, which might include secondments from the private sector.
3. The Listing Rules should be changed to allow dual-class share structures within the premium listing segment by creating a new category of listing. To safeguard investors, certain conditions would need to be satisfied, including the following:
   1. the dual class structure should last for a maximum of five years;
   2. the maximum weighted voting ratio should be 20:1, meaning that holders of weighted votes would need to hold a minimum economic stake in the company;
   3. only directors of the company should be able to hold weighted voting shares;
   4. the matters on which weighted votes could be cast should be limited to blocking a takeover of the company and any resolution to remove the holder as a director; and
   5. there should be limits on transfers of weighted voting shares, with the shares converting to regular voting shares (with certain exceptions).
4. The standard listing segment should be re-positioned and promoted more effectively as a venue for all types of company to list. The segment should be re-named (the review gives the name “Main Segment” as a possible new name), and investors should develop guidelines for companies on the “rebooted segment” to be included in indices.
5. The “free float” requirement should be reduced from the current 25% level to 15%. The paper also suggests certain technical modifications to how this figure is calculated. In addition, alternative, objectively assessable measures should be introduced for companies to show sufficient levels of liquidity in their shares. For larger companies, this would mean demonstrating a minimum number of shareholders, a minimum number and market value of publicly held shares, and a minimum share price. Smaller companies would be able to adopt the current model for AIM, using an FCA-authorised broker to supply liquidity.
6. The rules around special purpose acquisition companies (SPACs) should be revised. This would include removing rules that result in a suspension of trading in a SPAC’s shares when an acquisition is announced in favour of other protections, such as more detailed disclosures to the market, a requirement for a shareholder vote, and a right for shareholders to redeem their shares.
7. The Treasury should carry out a fundamental re-think of the UK’s prospectus regime. In particular, it should consider creating separate regimes for offering securities to the public and for seeking admission to a regulated market (such as the London Stock Exchange Main Market) and adapting prospectus exemption thresholds for different types of transaction. New capital raises by existing listed companies should either require no prospectus at all or at least be subject to “slimmed-down requirements”.
8. As part of this re-think, the Government should consider whether prospectuses drawn up in other jurisdictions could be recognised in the UK, removing a significant burden for overseas companies looking to access equity in the UK. Investor protection would be achieved instead through listing eligibility criteria administered by the FCA.
9. The existing prospectus liability regime should be amended so as to make including forward-looking information in prospectuses easier. Whilst directors would remain liable for any inaccurate information, they would have a defence in relation to forward-looking information if they exercise due care, skill and diligence in putting the information together and honestly believe it to be true when it is published.
10. As an alternative to demonstrating a three-year track record, the existing track record requirements for scientific research-based companies should be expanded to a wider range of high-growth, innovative companies across a variety of sectors which are able to show that they are sufficiently mature to obtain a listing.
11. Currently, an applicant for premium listing must provide historical financial information covering at least 75% of its business for a three-year period. This 75% test should apply to only the most recent financial period within that three-year period.
12. The Government should consider how to utilise technology to increase retail investor participation in corporate actions and stewardship. The paper notes that younger generations of retail investors now expect smoother processes for registering their views as shareholders.
13. The Government should re-establish the Rights Issue Review Group (RIRG) to consider capital raising models used in other jurisdictions with a view to facilitating a quicker and more efficient process of raising capital and more easily involving retail investors. The paper notes Australia’s “RAPIDS” model, under which an issuer can raise funds on an accelerated timetable and investors can renounce their entitlements off-market, as an example.
14. The FCA should review the new rules on publication of connected analyst research and the inclusion of unconnected analysts in the IPO process. The review suggests that the new rules have not led to any significant increase in unconnected analyst research and may be unduly lengthening the IPO timetable and increasing costs for issuers.

The review’s recommendations would need to be implemented by a combination of bodies, including the FCA and the Treasury. The Chancellor of the Exchequer has confirmed that he is keen to move quickly to consult on the recommendations. The Government will now examine the Review’s recommendations closely and set out next steps.

Court considers whether expert made error on completion accounts mechanism

The High Court has had to consider whether an expert appointed to determine disputes between a buyer and a seller over a completion accounts mechanism had made a manifest error.

What happened?

Flowgroup plc v Co-operative Energy Ltd [2021] EWHC 344 (Comm) concerned the sale of shares in a gas and electricity supply company. The terms of the sale were set out in a share sale and purchase agreement (SPA).

Under the SPA, the price for the shares was to be adjusted after completion of the sale to reflect the company’s working capital at the time of completion. This mechanism – usually referred to as a “completion accounts” mechanism – is seen frequently on trade sales.

The mechanism, which took a relatively standard form, required the buyer to prepare a “completion statement” setting out the company’s working capital at completion, which would then result in a balancing payment.

The seller was entitled to dispute the statement if it disagreed with it. If the parties could not reach agreement, the matter would be referred to an expert. The SPA stated that the expert’s decision would be binding on the seller and the buyer unless the expert made a “manifest error”.

As is usual, the SPA set out a hierarchy of accounting bases that were to be applied when preparing the completion statement. These were:

• first, specific accounting policies set out in the SPA;
• to the extent not covered by those policies, on a basis consistent with that used in the preparation of the company’s annual accounts; and
• to the extent still not covered, in accordance with UK GAAP.

The buyer prepared the completion statement and the seller disputed it. The matter was referred to an expert accountant, who reached a determination on the amount of working capital.

However, the seller claimed that the expert’s decision should be set aside because she had made a “manifest error”. In particular, the seller argued that the expert had, among other things, misinterpreted the hierarchy of accounting principles in the SPA.

The court had to decide two questions.

• What was meant by the term “manifest error”?
• Had the expert in fact made a manifest error when applying the hierarchy?

What did the court say?

The judge began by assessing the phrase “manifest error”. The seller had argued that these words pointed towards an error that was capable of being shown to be wrong on the face of it when set against the correct answer. In other words, an error would be manifest if it was possible merely to show that it was wrong, however complex or difficult the question was.

The court disagreed. It preferred the buyer’s argument based on previous case law, namely that, to be “manifest”, an error needed to an “oversight or blunder so obvious” that there could be “no difference of opinion” that it was an error, or, to put it another way, a “howler”.

This followed from the fact that, if parties to a contract choose to subject their disputes to expert determination, they will generally be held to that choice. The courts will interfere with an expert’s decision only in “confined circumstances”.

The court then proceeded to discuss whether the expert had in fact made a manifest error. The seller argued that, among other things, the expert had misinterpreted the relevant provisions of the SPA, and that this had automatically caused her to commit a manifest error.

The judge disagreed. Rather, this question depended on whether the parties had given the expert authority to interpret certain terms or principles set out in the SPA, which was, in turn, a matter of interpreting the SPA.

If the parties do not give an expert authority to interpret the contract but the expert nonetheless does so, the expert will be acting outside their authority and their decision will be susceptible to challenge. But, if the parties engage an expert on a “broad and expansive” basis to determine matters of contractual interpretation, a challenge could rise only where there is a manifest error.

In this case, the SPA gave the expert authority to determine “any dispute arising in connection” with the completion accounts mechanism. In the judge’s view, this permitted the expert to interpret the relevant parts of the SPA. In addition, it was clear from correspondence that the parties had contemplated that the expert might be asked to interpret certain terms of the SPA.

What does this mean for me?

The decision illustrates the importance when using a completion accounts mechanism of ensuring that any expert dispute mechanism is properly drafted. The following points are worth bearing in mind.

• Ideally, the SPA should make it clear what matters are to be within the expert’s competence. In other words, it should expressly establish the limits of the expert’s authority. If the expert is not to interpret any terms of the SPA, this should be set out clearly.
• The SPA should also set out what matters the expert is to determine. This includes what factors the expert may and may not take into account when reaching their decision.
• Generally speaking, a court will not interfere with an expert’s decision. If the parties want the ability to challenge a determination in court, it would be prudent to say this in the SPA.
• Case law has established when the courts will step in to correct a manifest error. The bar for intervention is high. If the parties wish to set a lower standard for challenging an error in the expert’s determination, they should set this out in the SPA.
• If a party is likely to want to challenge the expert’s decision, they should consider doing so early on. As we saw in our Corporate Law Update two weeks ago, participating too substantially in the determination process may be seen as an indication that a party has accepted the expert’s jurisdiction or is at least prepared to see the process play out before raising any challenge.

Restrictive covenants were not unenforceable restraints of trade

The Court of Appeal has held that restrictive covenants in a bespoke services agreement were not “restraints of trade” and so were enforceable.

What happened?

Quantum Actuarial LLP v Quantum Advisory Ltd [2021] EWCA Civ 227 was an appeal from an earlier High Court decision concerning a company that ran a pensions advisory business. For more information on the background to the case, see our previous Corporate Law Update.

In brief:

• As part of a restructuring that involved hiving out part of the company’s business, a limited liability partnership (LLP) was set up to service clients in such a way as to cover the LLP’s costs but not provide it with a profit. The relevant arrangements were set out in a service agreement.
• The services agreement contained restrictive covenants preventing the LLP from soliciting or performing services for existing or potential clients for a period of 12 months after the expiry or termination of the services agreement.
• The agreement had an initial fixed term of 99 years. This meant the earliest it could be terminated by notice was 6 April 2106. In effect, this meant the restrictive covenants would last for 100 years.

A bit more about restraints of trade

A covenant that restricts a person’s ability to trade freely can be unenforceable if it is wider than reasonable by reference to the interests of the parties concerned and the interests of the public. In deciding whether a covenant is enforceable, the courts ask three basic questions.

• Does the covenant in fact restrict the person’s ability to trade freely?
• If it does, does the law classify it as a restraint of trade? That is: is the covenant subject to the “doctrine of restraint of trade”?
• If it is a restraint of trade, is it reasonable? In assessing reasonableness, the court will look at various factors, including what the covenant is looking to achieve, the duration and breadth of the covenant, the bargaining power of the parties, and whether the restriction impacts the public.

At the time the LLP launched its appeal, the main test for deciding whether a restrictive covenant is subject to the doctrine was the so-called pre-existing freedom test. Under this test, if a party is entirely free to trade as it wishes before it enters into a restrictive covenant, the covenant will amount to a new fetter on its freedom and will be subject to the doctrine. An example might be where a person who sells a business agrees not to compete with the business for a time after the sale.

But if the covenant forms part of the very transaction that gives the party the ability to trade, the doctrine does not apply. An example is where a person takes a lease of land and agrees not to use it for certain purposes. Before the lease, that had no right to use the land and so the covenant does not hamper their existing freedom to trade using the land.

However, part-way through the appeal, the Supreme Court delivered its judgment in Peninsula Securities Ltd v Dunnes Stores (Bangor) Ltd [2020] UKSC 36. In that case, the court rejected the pre-existing freedom test and adopted the trading society test. Under that test, a covenant will not be subject to the doctrine if it is of a kind that has passed into the normal currency of commercial relations.

What happened in the High Court?

The LLP challenged the restrictive covenants, claiming they were unenforceable because they were “restraints of trade”.

The High Court rejected the LLP’s claim, noting that:

• the LLP had no pre-existing business and had been set up for the purposes of the transaction, and so the covenants could not be said to be restraining its trade; and
• even if the covenants were restraints of trade, the services agreement was a “bespoke agreement, fashioned to address the competing needs and interests of a group of professional people”. The covenants were therefore reasonable.

The LLP appealed to the Court of Appeal. Following the decision in Peninsula, it argued that the trading society test applied in all circumstances, including to a new kind of contract, such as the services agreement. It said that the covenants in that agreement did not “come close” to any established category of covenant and so had to be assessed as restraints of trade.

What did the Court of Appeal say?

The Court of Appeal dismissed the appeal. It rejected the idea that the trading society test set out in Peninsula is now the sole test that applies to all kinds of covenant. If that were the case, any contract that is “novel” or bespoke would automatically fall within the doctrine of restraint of trade, in turn depriving the test of any “meaningful value”.

The court reiterated the High Court’s comments that the services agreement was a “private bespoke agreement created in very specific circumstances arising out of a complex corporate restructure”, “fashioned to address the competing needs and interests of a group of professional people”.

As a result, it was not possible to analyse whether the covenants had passed into the accepted and normal currency of commercial or contractual dealings. Instead, they had to be considered "on [their] own terms and … circumstances".

Finally, the court found that the covenants would have been reasonable had they been restraints of trade. Its reasoning for this overlapped with its analysis of whether the covenants were in fact restraints of trade, but the court was not shy about this. It noted that considerations of reasonableness can “inform both stages of the exercise”.

What does this mean for me?

This is quite a technical decision, but the Court of Appeal’s comments show that it is important not to take too rigid and doctrinal an approach when agreeing, drafting or challenging a restrictive covenant.

Here, the court was willing to keep the circumstances in which a covenant can be challenged broad, and it was prepared to accept some blending of questions of reasonableness into that analysis. It was also prepared to uphold the High Court’s judgment that the bespoke terms of the agreement in this case pointed towards a balanced and negotiated set of covenants.

Ultimately, courts will also take a step back and look at a restrictive covenant in the round. If the covenant is measured, has been thought through, is not clearly disproportionate and forms a sensible and legitimate part of a commercial arrangement, they are not likely to invalidate it.

Parties looking to incorporate restrictive covenants, such as non-compete, non-solicitation and non-use clauses into a contract, should consider the following.

• What is the purpose of the restrictive covenant? What is it seeking to protect? Does it form a legitimate part of the commercial arrangement, or does it merely exploit a weaker party’s position?
• Is it a standard kind of restrictive covenant? If so, a court is more likely to find that it forms part of the “normal currency” of commercial arrangements and uphold it.
• Does it go further than reasonably necessary to protect a party’s interests? Will it last for a long time after the contract ends? Does it cover a wide geography? Does it discriminate between different types of business or use? Are there any sensible exceptions? The broader and less nuanced the covenant, the more likely it will be exorbitant and unenforceable.
• Have the parties taken legal advice? If parties have been properly advised, a court is much less likely to find there has been any oppressive behaviour causing the covenant to be invalid.

Consent of “beneficial owner” sufficient to invoke Duomatic

The Privy Council has held that the assent of the sole ultimate “beneficial owner” of a company was sufficient to invoke the Duomatic principle.

What happened?

Byers v Chen Ningning [2021] UKPC 4 concerned a company (PFF) incorporated in the British Virgin Islands (BVI) to carry on the business of entering into certain derivative contracts. PFF was owned 100% by another company (PISG), which was, in turn, owned 100% by a Miss Chen.

At one point, the market in these derivatives collapsed and PFF found itself in financial difficulty. It borrowed a significant sum from another company (Zenato) controlled by a business acquaintance of Miss Chen.

However, the market later improved, allowing PFF to access funds. It did so and, in November 2009, used the monies to repay the loan from Zenato. However, PFF remained insolvent and, in December 2009, it applied in the BVI to appoint joint liquidators.

In 2014, PFF’s liquidators brought proceedings against Miss Chen to recover the amounts paid to Zenato. They claimed that she had been a director or shadow director of PFF at the time of the payments and, by directing the repayments to Zenato, had breached her fiduciary duties to PFF.

It was not disputed that directing the repayments to Zenato at a time when PFF was insolvent amounted to a breach of duty. The more interesting question was whether Miss Chen was in fact a director of PFF when the repayments were approved.

Miss Chen argued that she had resigned in May 2009 when she sent a letter of resignation to herself as the sole director of PFF. At the time, PFF’s articles stated:

A director may resign his office by giving written notice of his intention to the Company and the resignation has effect from the date the notice is received by the Company at the office of its registered agent or from such later date as may be specified in the notice.

In this case, there was no evidence that Miss Chen had served her resignation letter on PFF’s registered agent. However, she argued that she had been acting on behalf of PISG and that, by doing so, she had given consent on behalf of PISG to amend PFF’s articles of association pursuant to the Duomatic principle so that her resignation became effective when received by PFF.

The liquidators argued that, even if Miss Chen had tendered her resignation, the subsequently revoked it by her actions, causing her to remain a director of PFF. Although, under common law, a director cannot revoke a letter of resignation once tendered (Glossop v Glossop [1907] 2 Ch 370), the liquidators said that, by virtue of the Duomatic principle, Miss Chen, as the ultimate beneficial owner of PFF (that is, the sole owner of PISG, itself the sole shareholder of PFF), had in fact consented to her letter of resignation being revoked.

What did the court say?

The Privy Council agreed with the liquidators.

The Councillors referred to various cases that have previously established that the beneficial owner of shares can give their consent for the purposes of the Duomatic principle. For example, in Shahar v Tsitsekkos [2004] EWHC 2659 (Ch), the court suggested that the beneficial owner under a nominee arrangement (a type of bare trust) could give their consent for the purpose of Duomatic. In Dickinson v NAL Realisations (Staffordshire) Ltd [2019] EWCA Civ 2146, the court reached a similar conclusion in principle in relation to a discretionary trust.

The Council said that, by virtue of those principles, Miss Chen was able to give consent under the Duomatic principle as the beneficial owner of PFF. She had given her informal consent to the withdrawal of her own letter of resignation and, hence, remained a director.

The Council went on to find that Miss Chen had authorised the repayments to Zenato and so had breached her fiduciary duties to PFF.

How did the court reach its conclusion?

In some ways, the decision is not surprising. The courts have been ready to find that a beneficial owner’s consent is perfectly satisfactory to invoke the Duomatic principle.

However, what is interesting about this case and different from previous decisions is that Miss Chen does not in fact appear to have been the beneficial owner of PFF’s shares.

Miss Chen was the sole shareholder of PISG, which was, in turn, the sole shareholder of PFF. This will have given Miss Chen control over PFF and, through PISG, 100% of the economic interest in PFF. It would be common to describe someone in Miss Chen’s position informally as the “ultimate beneficial owner” (or “UBO”) of PFF.

However, as a matter of law, unless PISG held the shares in PFF on trust for Miss Chen, then Miss Chen was not in fact a beneficial owner of the shares in PFF. Rather, she was the legal and beneficial owner of the shares in PISG, and PISG was the legal and beneficial owner of the shares in PFF. This reflects core principles of property ownership under English law and the cardinal principle that a company is a legal person separate from its members.

This matters because earlier cases, such as Shahar and Dickinson, concerned the consent of someone who did have a beneficial interest in the company’s shares by virtue of a trust. Those are quite different circumstances.

Nonetheless, the Council in this case reached its conclusion on the basis that Miss Chen was the “beneficial owner” of PFF. In doing so, it followed its earlier judgment in Ciban Management Corpn v Citco (BVI) Ltd [2020] UKPC 21. However, in that judgment, the Council, despite using similar language, was concerned with whether an individual had given consent for the purposes of the Duomatic principle as agent of a company’s registered shareholder. That involves a different analysis and follows more the line of argument that Miss Chen had put forward in this case.

Although the Council in this case adopted the term “ultimate beneficial owner”, we suspect, with respect to the Council, that the decision can in fact be analysed as one where Miss Chen was acting as PISG’s agent and so gave consent on behalf of PISG for the purpose of the Duomatic principle, rather than “directly” as the beneficial owner of PFF, with the term “beneficial owner” acting as shorthand for this arrangement. That is more in tune with both Miss Chen’s argument and Ciban.

That said, the distinction may, in practice, be moot. In many (if not most) cases, where the ultimate beneficial owner of a company has become substantially involved in the company’s affairs, there will be a strong argument that they have begun to act on behalf of any intermediate companies, particularly where indirect ownership is through a chain of wholly-owned companies.

What does this mean for me?

Decisions of the Privy Council are not technically binding in English law but are highly influential in English proceedings. This decision shows how easy it can be to alter a company’s constitution, structure or management without necessarily following the relevant procedures. Sometimes this can turn out favourably for one party or another. At others, it can give rise to unforeseen consequences.

Companies that wish to avoid a risk of the Duomatic principle applying in unexpected ways should ensure that all constitutional decisions are formally documented and that they follow all applicable procedures, including passing a formal resolution or holding a meeting.

Similarly, an ultimate beneficial owner of a company should take care when becoming involved in that company’s affairs. There is always a risk that the owner could end up effecting constitutional change without realising it. Again, any involvement and the basis on which it occurs should be carefully documented. This applies whether the beneficial owner is an individual or a company.

Also this week…

• ESMA launches new prospectus disclosure Q&A. The European Securities and Markets Authority has now published its final Q&A on disclosure requirements under the EU Prospectus Regulation. The Q&A replace the former recommendations issued by the former Committee of European Securities Regulators (CESR) (the CESR recommendations) for prospectuses approved within the European Union. Issuers seeking approval for a prospectus in the UK should continue to follow the CESR Recommendations for the time being. For more information, see our previous Corporate Law Update.
• ICAEW responds to FRC proposals to reform corporate reporting. The Institute of Chartered Accountants in England and Wales has published its views on the recent proposal by the Financial Reporting Council (FRC) for a new “principles-based framework” for corporate reporting. (For more on that proposal, see our previous Corporate Law Update.) The Institute welcomes the FRC’s discussion paper and notes that “regular and robust challenge of the current reporting regime is important”, but suggests revisiting the FRC’s proposed model following the outcome of the Government’s forthcoming consultation on corporate governance.