Ashurst and Practical Law Corporate Update Q2 2023

The articles below were written by Ashurst LLP and Practical Law Corporate in Q2 2023 and first published in the company law section of PLC Magazine, the leading monthly magazine for business lawyers advising companies active in the UK.

1. Share purchase agreement: breach of no MAC warranty

Summary。高等法院认为莎尔的卖家es were in breach of a warranty in the share purchase agreement (SPA) that there had been no material adverse change (MAC) in the target company’s prospects since the date of its last accounts.

Background。If a warranty in the SPA proves to be untrue and the buyer suffers loss as a result, it may seek to recover damages by bringing a breach of contract claim against the seller. A buyer will often seek to derive some reassurance by including a warranty in the SPA confirming that the target company has not suffered a MAC since the last accounts date.

When giving warranties to the buyer it is common practice for the seller to negotiate contractual limits on its liability under those provisions including, for example, a cut-off date by which the buyer must notify the seller of any warranty claims and an express exclusion of the buyer’s right to bring a warranty claim if the buyer was aware of the facts giving rise to the claim at the time it entered into the transaction.

Facts。D bought all the shares of a company, C, from two individuals (together, G) in October 2018. D subsequently assigned the benefit of its rights and claims under the SPA to a group company, S.

The SPA included various warranties concerning C’s business, including warranties that:

• There had been no MAC in the turnover, financial position or prospects of C since the date to which C’s last annual accounts were drawn up (the no MAC warranty).
• All financial and other records of C had been properly prepared and maintained, and did not contain any material inaccuracies or discrepancies (the records warranty).

The SPA excluded G’s liability for breach of warranty claims unless D gave written notice within 24 months of completion summarising the nature of the claim and the amount claimed. The SPA also incorporated standard provisions permitting D to bring a claim despite knowledge of breach of warranty.

C’s ability to consistently generate future revenues was critical for D. G produced an ambitious set of financial forecast documents indicating significant future increases in C’s gross profit and detailing C’s existing sales, pipeline, invoicing schedules and financial position. Among other things, the forecast documents indicated that C would win four new projects with an estimated value of over £5.5 million.

After completion, D realised that C’s earnings were much lower than suggested in the forecast documents and that none of the four new projects were progressing as indicated. Revenues continued to remain low, with monthly accounts revealing net losses after tax. The position did not noticeably improve in 2019 and 2020, with C again failing to achieve its forecast earnings before interest, tax, depreciation and amortisation (EBITDA) levels.

2020年9月,D和年代的正式通知warranty claim. The notice identified claims under both the no MAC warranty and the records warranty, and specified a calculation for the total damages sought in respect of the alleged breaches.

D and S issued breach of warranty proceedings against G, arguing that there was a MAC in C’s turnover and prospects at completion on the basis that the turnover and prospects of the four new projects were not properly reflected in the forecast documents, thereby breaching the no MAC warranty. D and S also argued that G had breached the records warranty on the basis that the forecast documents contained material inaccuracies or discrepancies.

G disputed that any breach of warranty had occurred. G also argued that D and S had failed to provide notice of the claims in accordance with the requirements of the SPA, and that the matters giving rise to the claims were within D’s actual knowledge when it entered into the transaction.

Decision。The court held in favour of D and S in respect of their claim for breach of the no MAC warranty on the basis that there had been a MAC in C’s prospects, although not its turnover. It held that G had failed to establish any of the contractual defences on which it sought to rely to avoid liability for breach of the no MAC warranty.

建立a breach of a no MAC warranty involves determining, in respect of the relevant factor, both a baseline figure, which is an expected or forecast level, and an actual figure as at the date of the SPA, and assessing whether the difference between the two is so great as to be material. In determining materiality, the test is objective and involves considering whether a reasonable person who has entered into a transaction with the buyer’s objectives would seek to withdraw from or renegotiate the transaction if they knew of the change.

As to the meaning of a MAC in C’s prospects, it is impossible to specify any abstract definition for this purpose, and the issue should be approached by interpreting the term in the context of the transaction. Here, the parties’ entire negotiation was based on EBITDA levels and it was clear that the overriding primary factor was future gross profit.

On the evidence, and considering in particular the agreed pricing structure for the transaction, the baseline figure for C’s expected prospects for 2018 was £1 million, while the actual expected profits as they would have been assessed by a hypothetical objective third party in the position of the sellers at completion was £300,000. In the court’s view, the difference between the two clearly constituted a MAC in C’s prospects at completion, therefore giving rise to a breach of the no MAC warranty.

As to the meaning of a MAC in C’s turnover, the issue should be approached by ascertaining whether the turnover for the period concerned is significantly worse than a baseline. Unless the facts suggest otherwise, the baseline should be taken to be the company’s historic level of turnover as set out in the financial information provided by a seller.

尽管figu存在显著下降res, the court considered that, on balance, D and S had failed to make their case that the events, taken as a whole, showed a change in turnover that was so significant as to be material.

There was no breach of the records warranty relating to the accuracy of C’s financial and other records, as the forecast documents on which D and S relied for this purpose were not records within the meaning of the warranty. The court rejected D and S’s argument that the term “record” includes every document created by a business in the conduct of its operations.

Comment。虽然这很大程度上决定打开自己的足总cts and the terms of the particular SPA, it provides an interesting insight into the court’s approach to construing a no MAC warranty, which a buyer commonly seeks to include in an SPA to give it comfort concerning changes in the target company’s financial position since its last accounts. In particular, the decision provides an interesting distinction between the approach taken by the court to interpreting the meaning of a MAC in the target company’s prospects as opposed to a MAC in the target’s turnover.

Case:Decision Inc Holdings Proprietary Ltd and another v Garbett and another [2023] EWHC 588 (Ch)。

2. Conversion of shares: variation of rights attaching to class of shares

Summary。The High Court has held that the conversion of preferred shares into ordinary shares by a company was invalid as this amounted to a variation of the rights attached to the preferred shares for which the procedure set out in the articles of association was not followed.

Background。A share conversion involves changing one class of shares into another class in accordance with a provision in the company's articles of association. The Companies Act 2006 (2006 Act) contemplates shares being renamed or otherwise redesignated. A company must notify the registrar of companies if it assigns a name or other designation to any class of its shares (section 636, 2006 Act).

A share variation involves varying or abrogating the rights attached to a class of shares, either in accordance with a provision of the articles of association or, where there is no provision, with the consent of the holders of at least 75% of the nominal value of the relevant class of shares (section 630(2), 2006 Act) (section 630(2)).

Any shareholders not consenting to a share variation resolution can apply to court to have the variation cancelled if they hold at least 15% of the issued shares of the relevant class of shares, in which case the variation has no effect unless and until it is confirmed by the court. The court can disallow a share variation if it would unfairly prejudice the shareholders of the class represented by the applicant (section 633, 2006 Act) (section 633).

The 2006 Act does not expressly address whether a share conversion constitutes a variation or abrogation of the rights attaching to a class of shares.

Facts。The preferred shareholders, V and S, were significant investors and holders of preferred shares in a company, D. V and S benefitted from a number of special rights attached to the preferred shares, which were recorded in D's articles of association, including preferred returns on dividend or capital distributions, and a shareholders' agreement, including a put option obliging D to buy back some or all of the preferred shares.

D's articles of association provided for the preferred shares to automatically convert into ordinary shares on notice in writing from an investor majority (the share conversion article). The investor majority was defined in the articles as the holders of a majority of the preferred shares and ordinary shares in aggregate as if the shares constituted one class. As the ordinary shares accounted for almost 87% of D's shares, the ordinary shareholders could form an investor majority without V and S.

The articles of association also provided that a class of shares could be varied only with the written consent of the holders of more than 75% in nominal value of the issued shares of that class (the share variation article).

Ordinary shareholders constituting an investor majority gave notice to D requiring the preferred shares to be converted into ordinary shares in accordance with the share conversion article. D's solicitors informed V and S that their shares had been converted into ordinary shares.

V and S argued that the conversion of their preferred shares into ordinary shares was invalid, void and of no effect as their consent had not been obtained to vary the class rights as required under the share variation article, which took precedence over the share conversion article. Alternatively, the variation of their rights effected by the conversion, if valid, unfairly prejudiced them and should be disallowed under section 633.

D argued that the share conversion did not vary the rights attached to the preferred shares but was rather an exchange of shares. D also argued that no amendment had been made to its articles. In addition, D claimed that, although there were no preferred shares in issue after the purported share conversion, D was at liberty to issue more preferred shares on the same terms in the future and so the class of shares continued after the share conversion.

Decision。The court found that the conversion of the preferred shares into ordinary shares was invalid, void and of no effect as it amounted to a variation or abrogation of the rights attached to the preferred shares for which the consent of V and S had not been obtained, as required by the articles of association.

There was a conflict between the share conversion article and the share variation article. No reasonable person reading D's articles of association and other documents publicly available at Companies House, including forms SH01 filed by D, with knowledge of the substantial premium paid for the rights attaching to the preferred shares, would regard the share conversion article as capable of enabling an investor majority comprising ordinary shareholders to vary or abrogate the rights attaching to the preferred shares on a whim. It was not the intention of the parties when drafting the articles of association that the special rights attached to the preferred shares could simply be removed on conversion.

There was a clear drafting mistake on the face of the share conversion article in failing expressly to provide that it was subject to the share variation article. The only way to give business efficacy and integrity to the articles of association as a whole, and to give effect to the true bargain made between D and its shareholders, was to construe the share conversion article as being subject to the comprehensive protection of special class rights in the share variation article, which took precedence and needed to be complied with to effect any variation or abrogation of those rights.

As the share conversion was invalid, it was unnecessary for the court to consider the alternative claim that the share variation was unfairly prejudicial to V and S for the purpose of section 633. However, the court confirmed that a section 633 applicant must establish that the share variation is both prejudicial and unfairly prejudicial. Here, on the artificial hypothesis that the share variation had complied with the articles and consequently been judged to be valid, V and S might well have suffered prejudice from the share conversion but would not have been able to challenge it under section 633 because the prejudice would not have been unfair, assuming that the investor majority had not acted improperly or in bad faith.

In considering the scope of application of section 633, the court confirmed that the section applies to a variation of class rights effected in accordance with a provision of the articles of association, as well as to a statutory variation in accordance with section 630(2).

Comment。When determining the necessary procedure to validly effect a share conversion, companies should ensure that the drafting in their articles of association is clear and consistent, considering both the articles that deal with the mechanism for converting shares and any separate articles dealing with the variation of class rights. Particular care may need to be taken in relation to provisions that purport to enable a share conversion to be effected without the consent of the relevant class of shareholders other than on the occurrence of a limited set of agreed specified events.

The decision is also interesting as it indicates that where a share variation is effected in accordance with a company's articles of association, and without any allegation of shareholders acting improperly or in bad faith, it may be difficult to make out a claim for unfair prejudice under section 633. More generally, the decision contains useful commentary on the court's approach to construing and interpreting articles of association, the extrinsic evidence it will consider in doing so, and the circumstances in which it may be willing to imply terms or limitations into the articles of association.

Case:Re DnaNudge Ltd (also known as Ventura Capital GP Ltd v DnaNudge Ltd) [2023] EWHC 437 (Ch)。

3. LLP agreement: breaches and expulsion of member

Summary。The High Court has held that a member of a two-member limited liability partnership (LLP) committed serious and persistent breaches of the LLP agreement and was validly expelled from the LLP under the expulsion clause in the agreement.

Background。It is possible to expel a member of an LLP under an appropriate expulsion clause in the relevant LLP agreement. The expulsion clause should specify the grounds for expulsion, including breaches of the LLP agreement, and the procedure for expulsion (regulation 8, Limited Liability Partnership Regulations 2001 (SI 2001/1090); Eaton v Caulfield and others [2011] EWHC 173 (Ch)).

Expulsion clauses are construed strictly by the courts and if there is an ambiguity, it will often be construed against the persons seeking to exercise the power (Blisset v Daniel (1853) 10 Hare 493).

In the context of a partnership agreement, a serious breach is one that goes to the root of the good faith that should exist between partners and does not require the conduct complained of to be repudiatory in nature, that is, conduct entitling the aggrieved party to terminate the contract. A persistent breach is a breach that is repeated and non-trivial (Moody v Estate of the Late Norman Jones and others [2021] EWHC 3443 (Ch);DB Rare Books Ltd v Antiqbooks [1995] 2 BCLC 306 (CA)).

InHitchman v CBAS Services ((1983) 127 SJ 441), the Court of Appeal considered how to interpret an expulsion clause in a partnership agreement in order to avoid a member being required to consent to its own expulsion.

Facts。S and M entered into a business venture involving S agreeing to exploit software developed by M. They established an LLP, O, as a vehicle for the arrangement. The two members of O were S and a company, T, which was owned by M and of which he was the sole director. T granted S an end user licence for the software for teaching, seminars and presentations.

The LLP agreement permitted T to take decisions in relation to the day-to-day running of O, required members to show the utmost good faith to each other and to O, and reserved certain matters for the unanimous decision of the members. The expulsion of a member was not a reserved matter but was addressed by a specific expulsion clause giving O the power, by notice, to expel a member for any serious or persistent breach of the LLP agreement.

The LLP agreement required S to advertise the software and also display a specific notice confirming T’s ownership of the copyright in the software (the copyright notice) in seminars and presentations to be delivered by him.

T and O argued that S had seriously and persistently breached his obligations. They sought to expel S from O in accordance with the expulsion clause. They also argued that S had infringed copyright by displaying images of the software in two online presentations and engaged in passing off by referring to the software as being jointly owned in advertisements.

Decision。The court held that S was in serious and persistent breach of the LLP agreement by failing to comply with the advertising obligations in the LLP agreement but not for failing to ensure that copyright notices were displayed in online seminars and presentations. It held that the breach of the advertising obligations was a ground for expulsion, the decision to expel was validly made and the notice of expulsion was validly served.

In analysing the meaning of a serious and persistent breach, it is necessary to consider all relevant circumstances, including the nature of the agreement, the nature of the breach and the consequences of the breach. A serious or material breach is more than trivial and is likely to have a significant effect on the benefit that the innocent party would otherwise derive from the agreement but is something less than a repudiatory breach. A persistent breach requires the breach to be repeated and non-trivial.

Regarding the expulsion of S from O, the LLP agreement provided that the power to expel was vested in O. However, the court rejected the argument that, to validly expel S, S had to vote in favour of his own expulsion. Instead, the expulsion clause should be read as O acting by a majority of the members other than S, that is, T. In the communications preceding the expulsion, T had not acted in breach of the duty of the utmost good faith in the LLP agreement.

On the evidence, the court dismissed the breach of copyright claim as T and O had failed to show that the infringed work was communicated to the public. The passing off claim was also dismissed because they had failed to show evidence of loss or damage to goodwill.

Comment。A party to a commercial agreement will often have a right to terminate the agreement if the other party commits serious and persistent breaches of the agreement. This decision summarises the meaning of a serious and persistent breach in the context of an LLP agreement, providing useful guidance for the members of an LLP but also to parties to other commercial agreements, although much will depend on all the relevant circumstances, including the nature of the agreement, the nature of the breach and the consequences of the breach.

The decision is also interesting as it shows the commercial approach adopted by the courts followingHitchman。It also highlights that LLPs should ensure that the drafting in their LLP agreements is clear and comprehensive. LLP and partnership law can sometimes fill in gaps in the drafting of an LLP agreement, but it is better to deal explicitly with important issues in the agreement. Here, it was open for the issue of expulsion to be included as one of the reserved matters requiring the unanimous consent of the members.

Case:THJ Systems and another v Sheridan and another [2023] EWHC 927 (Ch)。

4. Derivative claim against directors: approach to climate risk

Summary。The High Court has refused permission for a claimant to continue a derivative claim against a company’s directors for alleged breaches of their duties in relation to the company’s climate change strategy.

Background。A derivative claim is a claim brought by a shareholder of a company against the directors under the Companies Act 2006 (2006 Act) in respect of a cause of action vested in the company and seeking relief on behalf of the company.

Leave of the court is not required to issue a derivative claim, but the claimant must obtain the court’s permission to continue the claim (section 261(1),2006 Act). The court must dismiss the application if the evidence accompanying it does not support a prima facie case for giving permission to continue the claim (section 261(2)(a),2006 Act). The court must refuse permission if it is satisfied that a person acting in accordance with their duty to promote the success of the company would not seek to continue the claim (section 263(2)(a),2006 Act).

Directors must act in the way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of the shareholders as a whole, having regard to a number of non-exhaustive factors, including the likely consequences of any decision in the long term and the impact of the company’s operations on the community and the environment (section 172,2006 Act) (section 172).

Companies are increasingly under pressure to address climate change in their strategies.

Facts。An environmental non-governmental organisation, C, holds a small shareholding of 27 shares in a multinational oil and gas company, S.

C argued that S’s directors had breached their legal duties to assess, disclose and manage material risks to the company under section 172. C argued that S’s directors had failed to set an appropriate emissions target, did not establish a reasonable basis for achieving a net-zero target in the climate risk strategy and had not prepared a plan to comply with an order made by the Hague District Court in 2021 requiring S to reduce its carbon dioxide emissions by 45% by 2030 under Dutch law (the Dutch order).

C issued a derivative claim in its capacity as a shareholder against S’s board of directors, alleging the breach of directors’ duties relating to S’s climate change risk management strategy. The claim was supported by a group of institutional shareholders that together held more than 12 million shares in S. In particular, C sought a declaration that the directors had breached their duties and a mandatory injunction requiring them to adopt and implement a strategy to manage climate risk in compliance with their statutory duties and to comply immediately with the Dutch order.

Decision。The court refused to give permission for C to continue the claim.There was no prima facie case for giving permission to continue the claim because, on the totality of C’s own evidence, the court was satisfied that a person acting in accordance with section 172 would not seek to continue the claim.

In considering whether the directors had breached their duty to promote the success of the company, the court found that C had failed to submit independent expert evidence showing that the directors were managing S’s business risks in an unreasonable manner or in a way that was not in the best interests of S’s members as a whole. Directors of a business of S’s size and complexity are entitled to consider a range of competing factors, the proper balancing of which is their decision and which the court is ill-equipped to interfere with. It was a matter for S as to how it exercised its discretion to comply with reduction obligations imposed by Dutch law. There was no duty in English law, beyond those outlined in the 2006 Act, requiring a director to comply with an order of a foreign court.

C代表年代试图寻求救济,往下h a small shareholding gave rise to a very clear inference that its real interest was not in how best to promote S’s success for the benefit of its members as a whole. Although C was supported by some institutional shareholders, they were a small proportion of the total shareholder constituency and it was the views of that constituency as a whole that were important in determining how S should best manage its climate change risk. The strength of the shareholder support for the directors’ strategic approach to climate change risk, taken from votes cast at S’s AGMs in 2021 and 2022 pointed strongly against granting C permission to continue the claim. C’s motivation in bringing the claim was ulterior to the purpose for which a claim could properly be continued.

In terms of relief, a mandatory injunction that S adopt and implement a strategy to manage climate risk in compliance with its statutory duties and to comply immediately with the Dutch order would be too imprecise to be enforced. It was not the court’s function to make a declaration expressing views as to the directors’ conduct. The proper forum for C to seek to achieve the change that it was pursuing was in a general meeting of S, as a shareholder.

Comment。This decision reflects the difficulties of bringing derivative claims challenging the good faith decision-making of boards of directors. Derivative claims are intended to be a rarity and the courts have not sought to expand their role over the years, highlighting that decisions on a company’s strategy are a matter for directors, not the court. Injunctions and declarations affecting the board oversight of a company must be approached with caution.

The decision also demonstrates the court’s reluctance to impose additional requirements on directors and that a high threshold will apply to using the derivative claims procedure under the 2006 Act as a route to challenging a company’s climate change strategy. Climate change risk must be considered by directors in the context of other considerations and is one of a number of risks for any board to factor into decision making.

This application has been keenly watched. It has certainly raised the profile of climate change risk with boards and the importance of developing robust climate change strategies. Despite this decision, which the court will consider again in an oral hearing, this is an area which is likely to see increased shareholder activism and litigation.

Case:ClientEarth v Shell Plc and others [2023] EWHC 1137 (Ch)。

The above articles were written by Ashurst LLP and Practical Law Corporate in
Q2 2023 and first published in the company law section of PLC Magazine, the leading monthly magazine for business lawyers advising companies active in the UK。