Company law update

The small printing company,
Lost My Name, which creates unique, personalised printed books, recently made headlines on Dragons’ Den after securing the largest deal in den history, departing with £100,000 in exchange for a 4 per cent stake
of the company. The deal highlighted the importance of choosing the right type of investment and the right investor for a business.

Just as every business is unique, so too is every investor. While the target company looking for
the investment funds must demonstrate what distinguishes its products and services from its competitors’ offering, and how it will generate
a return on investment, the investor must demonstrate what it can add to the business
to push it on to the next stage. According to
Piers Linney, the dragon who invested in
Lost My Name, “What you are bringing to
the table [as an investor] is providing advice
and the ability to raise the business.”

It is important to match the company’s
desired aims with those of the proposed investor.
For example, despite Linney having no previous experience in the digital publishing sector, he had extensive experience in constructing a successful marketing campaign; this being an area that was neglected by the co-founders of the business. Their aim was to increase the commercial opportunity for the product, making Linney
the ideal investor to help them achieve this.

The deal also raised an important issue regarding the possible conflicts that can arise when introducing a new investor into the structure of an existing business. In this case,
the involvement of other shareholders prevented the representatives of Lost My Name (who were also shareholders) from immediately accepting Linney’s offer as they had to agree his conditions with the existing partners. Fortunately for them this posed no issue; however this may not always be the case.

If you are looking for investment, it is important
to establish clear boundaries regarding the role
of any existing investors in advance of seeking new ones so as to avoid any potential conflict.

Where any new investor is taking an equity stake, it is likely that each of the existing shareholders’ shares will be diluted. It is
therefore important to ensure that the company’s constitutional documents such as its articles of association and any shareholders agreement are amended to reflect this, or new documents put
in place. This will ensure that each of the existing shareholders understands their rights and relations with each other, with the investor following receipt of the investment, as well as the issue of the new shares to the investor. It is also important for the document to specify what will happen if further funds are required, and how each investor will ultimately exit the business.

Rewriting clauses

Commonly known as the ’blue pencil rule’, the court has discretion to delete the void or illegal words contained in a clause within a commercial contract. If the clause still makes sense after these deletions, then it will be enforceable. However,
to make the clause valid, the court will not rewrite the clause, or add or substitute words in the clause to make it valid.

This principle was tested and challenged in the recent case of Prophet plc v Huggett [2014] EWCA
Civ 1013.

The case (which was originally heard in the High Court) had to determine whether a non-competition clause (i.e. a clause which restricts one party from competing with another) should be interpreted to correspond with the intentions of the parties at the time that the clause was drafted, or whether it should be read literally, which would offer the claimant no protection
at all.

Prophet Plc is a software developer and
supplier for the fresh produce industry. Prophet employed Mr Huggett as its sales manager.
He was responsible for developing new business and managing account relationships with Prophet’s customers. Hugget’s employment contract included a clause which restricted him from competing with the business for a period
of 12 months after the termination of his employment: “In any area and in connection
with any products in, or on, which he/she was involved whilst employed hereunder.”

Huggett resigned from his employment
with Prophet after finding employment with
K3 Business Solutions Limited (K3), a software supplier operating in the fresh produce sector and a direct competitor of Prophet.

Prophet sought an injunction preventing Huggett from working for K3 until his 12 month restriction had expired.

Huggett said that the products that he would be selling at K3 would be different to the products that he sold at Prophet, and he was therefore not in breach of his restrictive covenant.

The High Court originally upheld Prophet’s application. It agreed with Huggett that the clause offered Prophet with no protection because no competitor would be selling Prophet’s products; however, the court held that the clause did not reflect the parties’ true intentions. The court decided that adding the words “or similar thereto” to the end of the clause would produce
a commercially sensible result and would reflect the true intentions of the parties.

Huggett was therefore restricted from working
for K3 until the 12 month period had expired. Huggett appealed and the Court of Appeal allowed his appeal.

The Court of Appeal said that the meaning
of the clause was clear and that there was no
basis for a different interpretation. Huggett
was therefore not in breach of his non-compete restriction by working for K3. In fact, the non-compete restriction was deemed to be useless.

The Court of Appeal concluded that the draftsman had not thought through the detail and the concept of the clause in sufficient detail. The case is a reminder of the general principle that the court will not rewrite a clause, or add or substitute words in a clause to make it valid.

Transparency and trust

On 25 June 2014, the government introduced the Small Business, Enterprise and Employment Bill into parliament. The Bill aims to make the UK a trusted and fair place to do business by removing the uncertainty behind the ownership of UK companies. The Bill is currently going through the usual process which is required before it can come into force. The main proposals, if the Bill is given Royal Assent, are set out below:
Companies will be required to keep a public register of persons with significant control
over the company. Significant control has
been defined as those people who, directly
or indirectly:

(a) hold or control more than 25 per cent of
shares in the company;

(b) hold or control more than 25 per cent of voting rights; or

(c) are otherwise able to exercise significant influence over the company.

This requirement will apply to all UK companies and Limited Liability Partnerships unless they comply with chapter 5 of the Financial Conduct Authority’s disclosure rules and transparency rules.

This will therefore affect any companies which have nominee arrangements in place over
more than 25 per cent of their share capital. Corporate directors will be prohibited and any existing corporate directors will have to cease being directors of any UK company within
12 months from the relevant provisions coming
into force.

Bearer shares

The creation of new bearer shares will also be prohibited. Any existing holders of bearer shares will be required to cancel them, or otherwise convert them into registered shares within nine months of the relevant provisions coming into force. Any companies that have authority in their articles of association to issue share warrants,
will be permitted to amend their articles of association for the purpose of removing such authority, without the need for a special resolution.

Filing requirements

The existing requirements for companies to file an annual return will be replaced by a requirement to provide a statement of compliance to Companies House. Companies will have to confirm at least once in every 12 month period that the company information held at Companies House is correct and complete. If the company information is not correct, then companies will be able to simply update that information. SJ