Corporate update: the latest corporate law developments February 2024

Directors’ interests and conflicts

In Humphrey v Bennett [2023] EWCA Civ 1433 the Court of Appeal considered the provisions of the Companies Act 2006 relating to directors’ conflicts of interest and interests in transactions.

The statutory duties

Company directors are subject to various duties which govern the fiduciary relationship between them and the company for whom they act. A number of those duties are designed to manage the conflicts of interest that could arise between a director’s duty to the company and either the director’s own interests or their duties owed to a third party.

In particular:

• A director must avoid a situation in which they have, or could have, a direct or indirect interest that conflicts, or may possibly conflict with the interests of the company (known as the ‘section 175 duty’). There are some exceptions to this duty, such as where the conflict has been authorised by the other directors.
• If a director is in any way, directly or indirectly, interested in a proposed transaction or arrangement with the company then they must declare both the nature and extent of this interest to the other directors before the company enters into the transaction or arrangement (the ‘section 177 duty’). Again there are some exceptions, including where the other directors are already aware of the director’s interest.

The directors owe these duties to the company, meaning it is only the company that can bring a claim against a director for any breach. However, in some circumstances it may be possible for the shareholders to step in and bring a claim on behalf of, and in the name of, the company – known as a ‘derivative claim’.

The facts

Humphrey v Bennett involved a joint venture company set up by two couples to develop properties. The company was owned 51% by one couple (the Majority Shareholders) and 49% by the other couple (the Minority Shareholders). All four shareholders were also directors of the company at the relevant time.

The particular dispute related to a landlocked piece of land bought by the company. The intention was to acquire an adjacent plot which would give access to the land, obtain planning permission and then build 12 houses on the enlarged site. However, after planning permission was granted, the Majority Shareholders caused the company to transfer the property to a second company owned by one of the Majority Shareholders. The land was sold for the same price originally paid when the company acquired it.

The Minority Shareholders brought a derivative claim on behalf of the company alleging that by diverting the property away from the company for their own benefit, the Majority Shareholders had breached their duties as directors. In their defence, the Majority Shareholders argued that they asked the Minority Shareholders to contribute to funding the development but they had declined, confirming that they did not wish to pursue the project. This, said the Majority Shareholders, was sufficient to authorise the conflict of interest under the section 175 duty and to declare their interest in the transaction under the section 177 duty.

The decisions

At first instance the judge rejected the Majority Shareholders’ arguments, finding that they had no reasonable grounds on which to defend the claim. So the judge granted summary judgment (that is, a judgment without a full trial) in favour of the Minority Shareholders.

But the Court of Appeal disagreed. It found that if the Minority Shareholders had indeed rejected the suggestion of pursuing the development through the company and had agreed that the Majority Shareholders could pursue it outside of the company, it was possible that a trial judge could find this constituted the necessary authority under the section 175 duty. Similarly, taking into account the informal basis on which the company had been run, a trial judge could also find that the directors would have been aware of the Majority Shareholders’ interest for the purposes of the section 177 duty.

Comment

It is important to remember that this was an appeal against a summary judgment. The Court of Appeal did not decide that the Majority Shareholders had not breached their duties, rather that there was a reasonable prospect of their argument succeeding at a full trail.

A key factor in the court’s decision was the informal way in which the company had been run. There had been no formal board or shareholder meetings relating to the development, with one meeting cited in the case taking place in a Carluccio’s restaurant in Leamington Spa. It may be that in a company with a stricter approach to governance and decision-making, clearer disclosures and authorisations would be required to avoid breaching the relevant duties. It remains to be seen what approach the court will take once the full details of the Majority Shareholders’ defence is heard at trail.

Listing regime reform: FCA publishes detailed proposals

The FCA has published a consultation paper (CP23/31) setting out its finalised proposals for the extensive reform of the listed company regime. The proposals include a new single listing segment for equity shares of commercial companies that would replace the current premium and standard listing segments. It is hoped that the simplified regime will encourage a greater range of companies to list in the UK.

The FCA’s detailed proposals broadly maintain the approach set out in its May 2023 consultation (CP23/10), but some of its original proposals have been modified following feedback.

Key proposals for new listing regime

• The current premium and standard listing segments will be replaced with a single segment for equity shares of commercial companies – to be known as “equity shares (commercial companies)” (ESCCs). The rules of the new segment will be based on current premium segment rules but with modifications to some eligibility criteria and continuing obligations.
• Significant transactions (Class 1) and related party transactions by ESCCs will no longer require shareholder approval but more disclosures will be required in transaction announcements. Shareholder approval will continue to be required for reverse takeovers.
• The role of sponsors will be retained, but with less formal involvement on significant transactions than is currently the case.
• Five new listing categories in total will be created, including a transitional category for commercial companies currently with a standard listing.
• A completely new “UK Listing Rules” sourcebook (UKLR) will be prepared (a first tranche of draft ESCC rules has been published in the consultation paper).

Eligibility for new ESCC segment

The eligibility criteria for the new segment will generally be based on the current premium segment criteria. However, companies will no longer need to have a three-year revenue track record, three years of audited historical financial information, or a “clean” working capital statement. This should make it easier for high growth and earlier stage companies to join the new segment (although prospectuses will still require disclosure of financial track records and a working capital statement).

The current independence and control of business requirements will no longer apply, except in the case of an ESCC with a controlling shareholder (where a relationship agreement will be required).

The current eligibility requirements for companies with a dual class share structure (DCSS) will also be significantly relaxed, with issuers permitted to have a DCSS at admission.

There will be restrictions on when enhanced voting rights can be cast, however, and those enhanced voting rights can only be held by specified persons (i.e. directors, natural persons who are investors/ shareholders, and employees).

Some important eligibility requirements will be retained, including the 10% free float, minimum £30m market capitalisation and the requirement to have a sponsor when first applying for admission.

Continuing obligations for ESCC companies

Significant transactions

In a key change from the current premium listing requirements, non-ordinary course of business transactions that currently meet Class 1 thresholds (significant transactions) will no longer require prior shareholder approval, the publication of an FCA-approved circular or the appointment of a sponsor. Instead (and illustrating the FCA’s move to a more disclosures-based regime), issuers will have to include more information about the transaction in their RIS announcement.

The rules that currently apply to reverse takeovers on the premium segment will largely be carried over to the new ESCC segment. Shareholder approval will continue to be required, as will the appointment of a sponsor and the publication of a shareholder circular.

Prior shareholder consent will also need to be obtained for other specified transactions, including share buy-backs, non pre-emptive discounted share issuances and cancellation of shares.

Related party transactions (RPTs)

As originally proposed, ESCC issuers will no longer need prior shareholder approval for a transaction with a related party. However, for larger RPTs (where the non-ordinary course transaction represents 5% or more in any of the class tests), the company will need to make an RIS announcement that includes prescribed information. As currently required, a sponsor will also have to be consulted and a “fair and reasonable” confirmation obtained.

There will be no notification requirements and no sponsor “fair and reasonable” opinion will be required for RPTs that fall below the 5% threshold.

Sponsors

The sponsor regime will be retained, with the sponsor’s role remaining largely unchanged on listing applications. However, there will no longer be a requirement to formally appoint a sponsor in relation to a significant transaction (and no sponsor declaration will be needed.)

On an ongoing basis, a sponsor’s role will generally be limited to advising on transactions that involve an issue of shares requiring a prospectus, larger RPTs (where a sponsor “fair and reasonable” opinion is required) or where a company seeks guidance, modifications or waivers to FCA rules.

Listing categories in the new regime

The FCA intends to create five new listing categories – ESCC, Shell companies, Transition, Secondary listings, and Non-equity shares and non-voting equity shares. Other listing segments will comprise of existing standard listing categories such as debt securities, warrants and OIECs.

Current premium segment companies will automatically be “mapped” to the ESCC. Existing standard segment companies will be moved to the new Transition category, the rules of which will be based on the current standard segment. This Transition category will have no end date, but issuers can apply to transfer to the ESCC if they wish to do so.

Next steps

Comments on the FCA’s current consultation are invited until 22 March 2024. The second tranche of draft listing rules are expected after that date and if the proposals for the new listing regime are adopted, the FCA expects that it would go live early in the second half of 2024.

Financial promotions: exemptions updated

From 31 January 2024 changes have been made to certain exemptions to the UK’s financial promotion regime. The changes are designed to tighten the protections afforded to potential investors and prevent high-risk investments from being promoted to ordinary consumers.

The financial promotion prohibition

A key part of the Financial Services and Markets Act 2000, which regulates the UK’s financial services sector, is the financial promotion prohibition in section 21. Broadly, this prohibits a person from communicating any invitation or inducement to enter into investment activities unless either that person is authorised by the FCA or the promotion is exempt.

Two of the key exemptions relate to high net worth (HNW) individuals and sophisticated investors. These are designed to enable small and medium sized companies to raise finance from so called “business angels”, without the cost of having to comply with the financial promotions regime.

As the thresholds for these exemptions have been in place for almost 20 years the FCA was concerned that unauthorised persons were relying on them to market high risk investments to ordinary consumers who, in reality, were neither HNW individuals nor sophisticated investors.

Changes to exemptions

To address the potential dangers identified by the FCA, the Financial Services and Markets Act 2000 (Financial Promotion) (Amendment) (No 2) Order 2023 made the following changes:

• the eligibility criteria for the HNW individual exemption have been increased to income of at least £170,000 (up from £100,000) or net assets of at least £430,000 (up from £250,000); and
• the eligibility criteria for the sophisticated investor exemption have been updated to remove the criterion of having made more than one investment in an unlisted company in the previous two years. The threshold for the “company director” criterion has also been increased to require the individual to have been a director of a company with an annual turnover of at least £1.6m (up from £1m).

These changes came into force on 31 January 2024. At the same time the investor statements associated with these exemptions were also updated. In order to rely on the exemptions, a person communicating a financial promotion must have a “reasonable belief” that the individual they are communicating to has signed the relevant investor statement. Investors will now have to select in those statements which of the specific eligibility criterion they meet. The FCA hopes that this will reduce the likelihood of investors who are not actually HNW individuals or sophisticated investors completing the statements.

Comment

Given the social, economic and technological changes of the last two decades, a review of the exemption thresholds was probably overdue. According to the FCA, the exemptions were being used to target consumers with high risk investments and scams, leading to an increased risk of harm.

However, the FCA did not take forward all of the proposals from its original consultation. In particular, it abandoned plans to shift the “reasonable belief” emphasis onto the firm communicating the financial promotion. This would have meant that, rather than simply relying on a signed investor statement, firms would have needed to show that they had a reasonable belief that an individual actually met the criteria for the relevant exemption. It was felt this would place too great a burden on the person communicating the financial promotion and that the changes to the exemptions and investor statements would provide sufficient protection and reduce the risk of consumer detriment.

First published in Accountancy Daily.