Corporate Law Update
- The court refuses to grant an injunction to stop an AIM company’s controlling shareholders from voting against a resolution at a general meeting
- A written resolution to appoint a director to a private company’s board was invalid because it had not been circulated properly
- The court gives further guidance on the meaning of the phrase “ordinary and proper course of business”
- The Government gives an insight into possible next steps on statutory audit and dividends
The High Court has refused to grant an injunction to prevent the controlling shareholders of an AIM company from voting at a general meeting against the re-appointment of the company’s directors.
Velocity Composites plc v Bridges concerned an aerospace company trading on the AIM market of the London Stock Exchange. 42.95% of the company’s shares were held by its three founders. The remainder were held by the company’s chairman, institutional investors and members of the public.
In connection with its IPO (and as is customary), the company entered into a relationship agreement with its three founders and its nominated adviser (Nomad). The purpose of the agreement was to allow the company to carry on its business independently without undue influence from the founders.
In particular, the relationship agreement stated that the founders would exercise their voting rights in the company so as to ensure (so far as they could) that the company and its business were managed “independently” of the founders and for the benefit of its shareholders. It also stated that the company was entitled to obtain an injunction to prevent the founders from breaching these obligations.
The company called an AGM, at which resolutions were proposed to re-elect its three directors. The company was concerned that the founders would oppose the resolutions, particularly the resolution to re-appoint the company’s executive chairman, due to concerns the founders harboured about the direction of the business and its management. It therefore sought an injunction from the court to prevent the founders from exercising the voting rights attaching to their shares.
What did the court say?
The court refused. The judge rejected the idea that allowing the founders to vote would operate against shareholders’ interests.
Rather, the purpose of the restriction in the relationship agreement was to prevent the founders from preferring their own interests over the interests of shareholders generally. It did not mean that the founders were prevented from voting contrary to the board’s recommendation.
In the judge’s view, the company’s board was still able to act lawfully and impartially, and for the benefit of the company’s shareholders, even if the founders voted against the resolutions, including if the executive chairman were not re-appointed as a result. The court was not prepared to conduct an objective exercise of determining what would or would not be in the shareholders’ best interests.
What does this mean for me?
Relationship agreements are a common arrangement where a publicly traded company has a controlling shareholder or bloc of shareholders. Indeed, listed companies (such as those on the Main Market) are required to have a relationship agreement in place. There is no strict requirement for AIM companies to do so, although it is common practice and often insisted on by Nomads and brokers.
It is tempting to assume that a company will be able to enforce the restrictions in a relationship agreement (or, indeed, any similar arrangement, such as a shareholders’ or investment agreement) by seeking an injunction. Often, the agreement will specifically provide for this.
However, this case is a stark reminder of two things:
- The decision whether to grant an injunction is always in the court’s gift. A court may take into account the fact that the parties have agreed to injunctions (as it did here) when deciding whether to grant one. However, ultimately it will follow principles of law in deciding whether to do so, and not blindly follow the parties’ contract.
- It is critical to draft any restrictions carefully. In this case, the founders’ only obligation was to vote in a way that ensured the company was run independently and in the shareholders’ interests. Merely voting against the executive chairman’s re-election did not breach that duty.
For the request for an injunction to have had any chance of success, the relationship agreement would surely have needed to restrict the founders specifically from voting on resolutions to re-elect the board. However, given that the founders owned just under 50% of the company, that was perhaps always unlikely to have been a commercially palatable position.
The High Court has held that a written resolution passed by shareholders holding 55.5% of a company shares was not valid because it had not been circulated properly.
Re Sprout Land Holdings Ltd (in administration) concerned the appointment of a director to a company. The company had three shareholders – Ms Tighe, Mr Fraser-Peters and Mrs Morris. Mr Fraser-Peters and Mrs Morris held 55.5% of the company’s shares between them, and Ms Tighe held 45.5%. Mr Fraser-Peters and Ms Tighe were also directors of the company.
In November 2018, Mr Fraser-Peters and Mrs Morris took steps to appoint Mrs Morris to the company’s board by passing an ordinary resolution. Mr Fraser-Peters prepared a written resolution of the company’s shareholders to achieve this. Given their combined shareholding, Mr Fraser-Peters and Mrs Morris were able to pass that resolution even if Ms Tighe were to vote against it.
On 19 November 2018, Mr Fraser-Peters emailed Ms Tighe to convene a board meeting on one hour’s notice to approve formally circulating the resolution to the company’s shareholders. Ms Tighe declined to attend on solely an hour’s notice, stating that any meeting that proceeded would be inquorate.
Mr Fraser-Peters signed the written resolution at some point on 19 November. Mrs Morris had actually signed the resolution two days earlier on 17 November. Mr Fraser-Peters did not send the resolution to Ms Tighe to sign, and so Ms Tighe did not sign it.
What was the issue?
Ms Tighe claimed that Mrs Morris had not been validly appointed as a director.
To be effective, a written shareholder resolution must comply with the Companies Act 2006 (the Act). In particular, it must be circulated in the way required by the Act. Although the Act allows either a company’s directors or its shareholders to propose a written resolution, in either case it must be the company that circulates the resolution to the shareholders for approval.
The company must send the resolution to all of its shareholders who are entitled to vote on it. It can send it to them all at the same time, or to each shareholder in turn. However, the resolution will not be invalid merely because the company fails to circulate it in this way.
Ms Tighe said that the resolution had not been circulated properly as required by the Act, because Mr Fraser-Peters had sent it out without the approval of a formal board meeting. Mr Fraser-Peters argued that he had authority, as a director, to circulate the resolution on behalf of the company.
What did the court say?
The court agreed. The judge found two problems with the resolution:
- The Act specifically requires a written resolution to be circulated by the company. This means the company’s directors must take the decision acting as a board. A single director of a company cannot simply circulate a written resolution acting alone, because this is an act of the director, not the company.
- The resolution had not been circulated to Ms Tighe. Although the Act says that a resolution can be effective even if it is not circulated properly, the judge felt this was designed to deal with an accidental failure. In this case, Mr Fraser-Peters deliberately refrained from sending the resolution to Ms Tighe, and so the resolution would not have been circulated properly in any case.
One point worth noting is that Mrs Morris had signed the resolution two days before the date on which Mr Fraser-Peters claimed it had been circulated. Helpfully, the judge said that, provided a resolution is circulated properly (which had not happened here), a shareholder can “signify agreement by a pre-circulation agreement”. In other words, it is possible to “pre-sign” a written resolution.
What does this mean for me?
For private companies, the written resolution procedure is a swifter and less onerous way to pass shareholder resolutions than holding a general meeting. But, unlike at a general meeting, there is no open forum for shareholders to raise concerns about or discuss their views on the proposed resolution.
The procedure therefore builds in various safeguards to ensure it cannot be abused, which companies and shareholders alike need to bear in mind:
- A shareholder cannot circulate a written resolution directly to other shareholders. The proposed resolution must be sent to the company’s board, who are then required to circulate it. If the board refuses to comply, the shareholder’s only remedy is to requisition and call a general meeting. If a shareholder suspects the company’s board is likely to resist the resolution, they may want to consider moving straight to requisitioning a general meeting, so as to avoid wasting time.
- The directors must decide collectively to circulate the resolution. They could do this by holding a board meeting or (if the company’s constitution allows) signing a “directors’ written resolution”. But a single director or group of directors cannot simply start sending out resolutions for signature.
- The resolution must be sent to all members who can vote on it. Although the Act makes allowances where a shareholder is accidentally left out, this will not work where the company deliberately keeps a shareholder in the dark.
In December 2017, we reported on the case of Koza Ltd v Akçil, in which the High Court gave guidance on the meaning of the phrase “ordinary and proper course of business”. Although the judge in that case was examining the wording of undertakings that had been given to the court, we noted that his comments might be helpful in interpreting the phrase in other contexts.
The Court of Appeal has now considered the case and provided some further useful guidance.
As a reminder, a dispute had arisen between rival parties over the management of a company.
Pending resolution of that dispute, the company undertook to the court that it would not "dispose of, deal with or diminish the value of any funds belonging to [it] or held to [its] order other than in the ordinary and proper course of business".
The company subsequently wanted to incur certain expenditure and asked the court whether that expenditure would fall within “the ordinary and proper course” of its business.
What did the court say?
The Court of Appeal made the following comments:
- Although the meaning of the phrase “ordinary and proper course” is a matter of law, the court will always look at the facts of the case to see whether the transaction in question was within the ordinary and proper course of business.
- In deciding whether a transaction is in the ordinary and proper course, the court will apply an objective test. It will consider the question against accepted commercial standards and practices for running a business.
- The question is not whether a particular transaction is “ordinary” or “proper”, but whether it takes place in the ordinary and proper course of the company’s business. So, it is perfectly possible for an unprecedented or exceptional transaction to form part of a company’s “ordinary” business.
- “Ordinary” and “proper” are separate requirements, and both need to be satisfied. In theory, it is possible for a transaction to take place in the context of a company’s ordinary business, but yet be improper (for example, because it is not carried out in the company’s interests or in good faith).
What does this mean for me?
Phrases such as "ordinary and proper course of business" or "ordinary course of business" appear frequently in all kinds of commercial agreement, including joint venture and shareholders’ agreements, agreements for the sale of shares in a company or a business, and financing arrangements.
Although the meaning of the phrase in any given contract will depend to a significant extent on the context and the parties’ intentions, the comments in this case give a good indication of how the court will approach any dispute.
The Government has said it will be consulting on this topic when it receives the outcomes from three ongoing reviews:
- The Independent Brydon Review on the Quality and Effectiveness of Audit, which was launched on 14 February 2019. As part of the review, the Government also launched a call for views, which closed on 7 June 2019. We await the outcome of that consultation.
- The Independent Kingman Review of the Financial Reporting Council, which was launched in April 2018 and published its final report in December 2018. The Government has already followed up on this by launching a consultation on proposals to implement the Review’s recommendations, including by establishing the new Audit, Governance and Reporting Authority (ARGA). That consultation closed on 11 June 2019.
- The Competition and Markets Authority’s study on the statutory audit market, which was launched in October 2018 and published its final report on 18 April 2019. (For more information on the report, see our previous Corporate Law Update.)
The Government has also confirmed it is currently considering other potential changes. These include:
- Strengthening the “net asset” test that applies when a public company pays a dividend. At the moment, a public company can’t pay a dividend unless its net assets are at least equal to its called-up share capital and undistributable reserves. This arises from a concern about companies potentially over-valuing goodwill.
- Introducing a new legal requirement for companies to state their level of realised profits as a separate item in their audited accounts. This would make the figure for realised profits subject to audit and make it clearer when a company is able to pay a dividend.
- Introducing a new ability for companies to declare and pay dividends based on an assessment of their solvency by their directors, rather than on the level of their distributable profits. This procedure is already used in other jurisdictions, such as Jersey.