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Draft with care

Debbie King considers two recent cases which highlight the need for scrutiny in drafting, the courts’ powers to rectify a company’s statutory registers, and new requirements for PSC information

21 September 2017

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In Watson and others v Watchfinder.co.uk [2017] EWHC 1275, the meaning of ‘directors’ discretion’ was considered in the context of the exercise of a share option agreement.

A services agreement was entered into between the company (A) and another company (B), and three directors of B entered into share option agreements with A. Each option agreement included a clause stating: “The Option may only be exercised with the consent of a majority of the board of directors of the Company.”

When the option holders attempted to exercise their options, A’s directors refused to issue the shares, simply because they did not consent to their issue. The existing directors of A had a conflict of interest in that the allotment of the option shares would dilute their existing shareholdings, so the option holders issued proceedings for specific performance.

The option holders’ claim succeeded. It was held that the directors’ discretion clause was not an unconditional right to veto the exercise of the options, or the share option agreements would be meaningless. The discretion should have been exercised in a way which was not “arbitrary, capricious or irrational in the public law sense”.

The court held that the clause was intended to put a restriction on the option, and in considering the request to exercise the options, the directors should have:

  • Undertaken a reasonable process, taking into account all material considerations (including each option holder’s performance from the date that they entered into the option agreements) and the potential consequences, and disregarding any irrelevant issues; and

  • Reached a decision which a reasonable decision maker would have decided in the circumstances.

The court held that the clause could not simply be ignored and the directors had not demonstrated a proper process in exercising their discretion. They had not discussed the issues and their decision had been arbitrary.

While this case only considered the exercise of directors’ discretion in the context of a share option agreement, it is clear that boards of directors must ensure that a reasonable process is in place and that both the process and decision (with reasons) are documented in case further scrutiny is required at a later date.

Restrictive covenants

Tillman v Egon Zehnder Ltd [2017] EWCA Civ 1054 considered the reasonableness of a non-compete restrictive covenant.

Restrictive covenants will be void for being in restraint of trade, unless the employer has a legitimate interest to protect and the protection sought is no more than is reasonable having regard to the interests of the parties and the public interest.

Ms Tillman was employed by Egon Zehnder Ltd (EZ) as a ‘consultant’ and her employment contract included the following provisions:

“4.5 You shall not, during the course of your employment, directly or indirectly, hold or have any interest in, any shares or other securities in any company whose business is carried on in competition with any business of the Company or any Group Company, except that you may hold or have an interest in, for investment only, shares or other securities in a publicly quoted company of up to a maximum of 5 per cent of the total equity in issue of that company.”

“13.2 You shall not without the prior written consent of the Company directly or indirectly, either alone or jointly with or on behalf of any third party and whether as principal, manager, employee, contractor, consultant, agent or otherwise howsoever at any time within the period of 6 months from the Termination Date…”

“13.2.3 directly or indirectly engage or be concerned or interested in any business carried on in competition with any of the businesses of the Company or any Group Company which were carried on at the Termination Date or during the period of twelve months prior to that date and with which you were materially concerned during such period.”

Ms Tillman resigned in January 2017 and then notified EZ that she wished to work for Russell Reynolds Associates in a similar role. EZ issued proceedings on the basis that Ms Tillman would be in breach of these clauses if she took up this role and sought an injunction to prevent her from taking up the role within the first six months following her resignation.

Ms Tillman argued that the restrictions were void on the following grounds:

  • The clause did not contain a territorial limitation; and

  • The phrase “interested in any business carried on in competition” was too wide. This phrase could be interpreted to mean that she would not be able to have a minor shareholding in a competitor for investment purposes which would be contradictory to clause 4.5.

EZ disputed this and argued the clause would be valid if the words “or interested” were severed from clause 13.2.3.

The Court of Appeal upheld Ms Tillman’s argument that the restrictive covenant was void due to the ambiguity regarding the phrase “interested in any business carried on in competition”. The words “interested in” could not be severed because the clause would still be too wide, as a shareholder of a business would still be “concerned in” that business. Further to this the court found that it could not sever the constituent parts of a single covenant.

Although this case concerned a contract of employment, the decision should be considered when drafting restrictive covenants within all commercial contracts which restrict trade, including share purchase agreements.

Rectifying statutory registers

In Kings Court Trust Ltd and other v Lancashire Cleaning Services Limited [2017] EWHC 1096, the court’s power to rectify a company’s statutory registers under section 125 of the Companies Act 2006 was considered and it was decided on the facts that the name of a deceased member could be replaced on the register of members with the names of his executors despite the fact that the executors had not yet obtained a grant of probate.

Following the death of the sole shareholder and director his shares passed to his executors by transmission and the company continued to trade under their instructions, but the company’s bank account was then frozen, as the deceased had not been replaced on the company’s registers, preventing the executors from paying employees and other creditors.

Whereas model articles 17(2) permit a deceased shareholder’s personal representatives to appoint a new director in circumstances where the company is left without a surviving director or shareholder, in this case, the company’s articles (table A with modifications) did not. The executors could therefore not update the register of members with their names and could not appoint a director and the company was left with no directors or shareholders.

As they were the owners of the shares, automatically by transmission, the executors argued that using the power in section 125 of the 2006 Act, their names should replace the name of the deceased, and there should be no need to wait for the grant of probate, and that once they were named, they could then appoint a director.

The judge held that the circumstances of this case were exceptional as the sole director and shareholder of the company had died. The normal practice would be to wait for the grant of probate before amending the register of members. However, in order to ensure the company’s survival, these executors needed to rectify the register prior to receiving the grant of probate.

When dealing with older companies that don’t adopt the model articles, it is therefore important to ensure that a provision similar to article 17(2) is included, particularly where there is a sole director and shareholder.

Updates to the PSC register

From April 2016, companies have had to compile and maintain registers of people with significant control (PSC). From June 2016 companies have had to ensure that the information on their confirmation statement is accurate and up to date, including the contents of their PSC register.

The initial requirement was that this information must be reviewed and updated at least once in each 12-month period. However, from 26 June 2017, a company must now also file a form at Companies House each time a change is made to the PSCs (forms PSC01 to PSC09).

The PSC register must be updated within 14 days of a change and the relevant PSC form must then be filed at Companies House within a further 14 days. Failure to file within this timescale could result in the company committing a criminal offence.

Practitioners acting on the transfer of shares should therefore ensure that any changes to a company’s PSCs as a result are dealt with and the relevant forms are filed as part of the post-completion formalities.

Debbie King is a partner and head of corporate at Farleys

 

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