Corporate update: the latest corporate law developments July 2024

Company’s articles amended by shareholders’ conduct

The High Court has held that the conduct of a company’s shareholders over the years had effectively amended the company’s articles of association to allow each shareholder to appoint a director by notice.

Articles of association

A company’s articles of association are the rules that govern its internal affairs. They form a contract between the company and its shareholders.

A standard set of articles is applied to all companies by default: Table A for companies incorporated before 1 October 2009 and the Model Articles for those incorporated after that date. Those default articles apply to the company to the extent that they are not excluded or modified by bespoke articles adopted by the company.

The Companies Act 2006 confirms that a company may amend its articles by special resolution of the shareholders. But there is a rule of law, known as the Duomatic principle, which allows shareholders to take decisions by informal, unanimous consent. Such a decision would be valid even if the required formal procedures (such as a special resolution being passed at a general meeting or by a written resolution) had not been complied with.

The facts

In Bramber Road Management Ltd, Re [2024] EWHC 51 (Ch) a management company had been established to own and maintain a courtyard development of four office units. Each unit holder was a shareholder of the management company.

When the relationship between the four shareholders broke down, two of them brought a claim against the others. They asked the Court to make various orders, one of which related to how directors of the management company were appointed.

The company’s articles of association disapplied the regulations of Table A dealing with the appointment of directors. But those regulations had not been replaced with any express provisions, meaning the articles were silent on who had the right to appoint directors and how that right was to be exercised. The Companies Act 2006 is also silent on how directors are to be appointed on the basis that it is something for each company to decide via its articles rather than being prescribed by statute.

The claimants asked for an order that each shareholder was entitled to appoint, remove and replace one director by notice to the company. They argued that historically, each shareholder had appointed a director by notice to the company without any board or shareholders’ resolution and that, as a result, the articles had been amended by conduct.

The decision

The Court found that the company’s articles of association vested the power to appoint directors in the board. This was based on a provision in the articles which stated that: “the powers of the [company] are to be exercised by the directors unless they are required to be exercised by the [company] in general meeting by statute or the articles”. Since neither the Companies Act nor the company’s articles required the appointment of directors to be dealt with in a general meeting, that meant that the power to appoint directors was conferred on the directors themselves.

But the Court then went on to consider whether the articles had been amended despite no special resolution having been passed. Examining the evidence of how the company had managed its affairs, the judge found that, since its incorporation, each shareholder had simply appointed (or replaced) their own director by giving written notice to the company. Applying the Duomatic principle, the judge found that, by their conduct over a period of time, the shareholders had informally agreed to amend the articles to permit directors to be appointed and removed in this way. All the shareholders were aware that no formal board or shareholder resolutions had been passed in relation to these appointments. The fact that it had occurred multiple times over several years meant that the shareholders had intended to amend the articles, rather than treat each appointment as an ad hoc exception.

The judge directed that an updated, amended copy of the articles of association be filed at Companies House so everyone was aware of the correct position.

Comment

It may seem surprising that the current shareholders in this case were unaware that, in fact, the company’s articles of association, to which they were subject, had been amended many years earlier without this change being formally recorded.

The case is a reminder of the need for companies to follow and document their agreed decision-making processes. Without this, those involved risk being held to historic informal decisions of which they are unaware and the full impact of which may not be appreciated.

Changes to UK merger control regime

One of the final Acts to make it through Parliament before it was dissolved for the general election was the Digital Markets, Competition and Consumers Act 2024 (DMCCA) which received Royal Assent on 24 May 2024. Amongst other things, the DMCCA will make changes to the UK’s merger regime.

The current merger regime

The merger regime is set out in the Enterprise Act 2002. It applies to transactions where two or more businesses cease to be distinct and one of the following tests is met:

• turnover test: the target’s annual UK turnover exceeds £70m; or
• share of supply test: the merger results in the combined businesses having a 25% or more share of sales or purchase in the UK (or a substantial part of it) of goods or services of a particular description.

The regime is a voluntary one: there is no obligation on either party to notify the Competition and Markets Authority (CMA) of a transaction or wait for it to be cleared. But a transaction that falls within the jurisdictional ambit of the regime is at risk of being reviewed by the CMA. If the CMA considers that the merger has resulted in a substantial lessening of competition, it could choose to impose significant remedies that may even require the buyer to divest itself of the entire target business.

The revised regime

Following a number of consultations, the Government confirmed that whilst the UK’s merger control regime was working well, it should be updated to focus on those mergers most likely to be harmful to competition and consumers. It believed that reviewing the jurisdictional thresholds would enable the CMA to better scrutinise potentially harmful mergers whilst reducing costs to business in other cases.

Accordingly, the DMCCA will make the following changes to the current regime:

• Increased turnover test: the threshold for the turnover test will increase from £70m to £100m.
• Additional acquirer focused test: there will be a new threshold for transactions where at least one party has a UK share of supply of at least 33% and annual UK turnover of more than £350m, and the other party is connected with the UK (either by being a UK registered business or body, carrying on business in the UK or supplying goods or services in the UK).
• Small mergers safe harbour: mergers between parties that each have an annual turnover of less than £10m will be exempt from the regime.

Comment

Whilst it is relatively easy to determine if a transaction is caught by the turnover threshold, the application of the “share of supply” test is more nuanced. It can be especially tricky to determine what is a particular market for goods or services, and therefore whether the combined businesses will trigger that share of supply test. In one famous case, the supply of bananas was held to be a market distinct from the supply of fresh fruit in general.

Having a general exception for smaller mergers, regardless of their market share, will be a relief for those businesses which are effectively a big fish in a small pond.

The provisions are not yet in force as secondary commencement regulations will be required.

Court of Appeal rules on valuation of partnership assets following dissolution

In Bahia v Sidhu & Anor [2024] EWCA Civ 605 the Court of Appeal held that on the dissolution of a partnership, the value of the partnership assets should be ascertained by the usual practice of a sale in the open market. Although not an absolute rule, exceptional circumstances would be required to justify a departure from this practice.

Dissolution of partnerships

When a partnership is dissolved, every partner is entitled to have the partnership property applied in payment of all the firm’s debts and liabilities and to have any surplus divided between the partners in accordance with their respective entitlement.

The dissolution process will involve the valuation of partnership assets, and if the parties cannot agree on the method of valuation, the Court will have to rule on how best to achieve a fair outcome. In the absence of specific provisions in the partnership agreement, case law has established that a sale of the partnership assets in the open market is usually the most appropriate way to achieve a full and fair value for those assets. In exceptional circumstances, however, the Court might order an alternative course of action and, for example, allow the majority of the partners to buy out the minority partner.

The recent Court of Appeal decision in Bahia v Sidhu usefully summarises the established legal principles, whilst highlighting when exceptional circumstances might justify another course of action.

Court of Appeal decision

The Court of Appeal unanimously overturned the decision of the High Court and directed that the dissolved partnership’s assets be sold at auction, rather than being transferred directly to one of the partners. (The High Court had directed that the value attributed to the assets was to be determined by an independent expert.)

Based on established legal principles and authorities, the Court of Appeal concluded that although there is no absolute rule that partnership assets should be sold on dissolution, it is the normal and usually the best method of determining a full and fair value for those assets.

The Court held that there may, however, be exceptional cases where an open market sale would be unfair or would not be the best means of achieving full value. These cases include:

• where one partner has a very small stake in the partnership and selling the business as a going concern would create disproportionate harm to the majority partners or to third parties;
• where a sale in the open market would obviously not maximise the value of anyone’s share in the partnership because the assets are worth little or nothing if sold separately from goodwill;
• where the partnership agreement provides for a buy-out on termination of the partnership or it can be inferred that this is what the contracting parties intended; and
• where the auction process could be used by one partner to drive up the price artificially, to the detriment of another partner who wants to buy the property.

In the current case, there were no circumstances to justify taking an exceptional course of action and a sale by auction of the partnership assets would achieve a fair outcome.

Commentary

Although the Court of Appeal confirmed that there is no absolute rule that partnership assets be sold in the open market upon dissolution, it also highlighted how rarely the courts have exercised their discretion to direct another course of action. In fact, in 150 years since the Court’s discretion was first identified, there has not been any reported authority in which the discretion has been exercised or even recognised as arising.

In practical terms, unless the relevant partnership agreement confirms otherwise, a court will almost always order the open sale of partnership assets as the fairest means of realising their true value. Partners who would prefer to have other options on dissolution should ensure that those options are expressly included in the relevant partnership agreement.

Supreme court clarifies impact of “reasonable endeavours” on force majeure clauses

The Supreme Court has unanimously overturned a decision of the Court of Appeal and held that a duty to use reasonable endeavours to overcome a force majeure event does not require the affected party to accept an offer of non-contractual performance (RTI Ltd v MUR Shipping BV [2024] UKSC 18).

Force majeure

A contractual force majeure clause will typically relieve one or both parties from performing the contract where that performance is impacted by events outside of the party’s control (for example, natural disasters, Government action or war).

Effective force majeure clauses will define what constitutes a “force majeure event” and will then cover the consequences of such an event. They will often expressly require the defaulting party to show that it used its reasonable endeavours to prevent, or at least mitigate, the effects of the force majeure event. Even where there is no express requirement, an obligation to use reasonable endeavours is likely to be implied into a force majeure clause.

The facts

The parties had entered into a shipping contract under which the shipowner (MUR) agreed to make shipments of bauxite, and RTI Ltd (RTI) agreed to make monthly payments to MUR in US dollars. The contract contained a force majeure clause which stated that neither party would be liable for a failure or delay in performance caused by a force majeure event (as defined). Significantly, the clause included a proviso that an event would only constitute a Force Majeure Event if “it cannot be overcome by reasonable endeavours from the Party affected.”

In 2018, RTI’s parent company became subject to US sanctions meaning that RTI could no longer pay MUR in US dollars. MUR claimed that this amounted to a force majeure event and suspended its shipments of bauxite. It insisted that it had the right to payment in US dollars and rejected RTI’s offer to make payments in euros and to indemnify MUR for any additional costs or exchange rate losses.

RTI brought an action against MUR for breach of contract on the basis that it had failed to use reasonable endeavours to overcome the effects of the force majeure (by rejecting RTI’s offer to pay in euros). This failure meant that MUR could not rely on the force majeure clause.

Following proceedings in both the High Court and the Court of Appeal, MUR appealed to the Supreme Court.

Supreme Court decision

The Supreme Court unanimously overturned the decision of the Court of Appeal and held that MUR was able to rely on the force majeure clause.

The fact that MUR had rejected RTI’s offer to pay in euros – i.e. non-contractual performance – did not constitute a failure to exercise reasonable endeavours to overcome the force majeure event. Without clear words requiring it to do so, MUR was not obliged to accept that the contract would be performed in any way other than in accordance with its terms. This was the case even if the non-contractual performance would have achieved the same outcome as contractual performance.

The Supreme Court based its judgement on the following four key principles:

• The object of a reasonable endeavours clause: The justification for a reasonable endeavours proviso is not to require a party to take reasonable steps to secure non-contractual performance, but to enable a contract to continue to be performed.
• Freedom of contract: Freedom of contract extends to freedom not to contract and parties are, therefore, free not to accept an offer of non-contractual performance.
• The importance of certainty in commercial contracts: Parties need to know with “reasonable confidence” whether or not a force majeure clause can be relied upon. If, as RTI had suggested, a party was required to accept non-contractual performance when it was not detrimental, that would require the parties to assess whether such a change was detrimental or whether it would achieve the same result as contractual performance. That would give rise to considerable legal and factual uncertainty.
• Clear words needed to forego valuable contractual rights: There was a clear contractual right for MUR to require payment in US dollars and clear words were required for a party to forego valuable contractual rights.

Comment

The Supreme Court’s decision reinforces the importance of certainty in commercial contracts, and for that it is to be welcomed.

It confirms that contracting parties cannot be required to accept non-contractual performance, even if that performance would cause no detriment and, in fact, would achieve the same outcome as contractual performance. That principle will apply to contracts containing force majeure provisions or any similar clause which might operate to exclude or amend contractual performance.

The Supreme Court also confirmed that parties are free to agree a different approach, for example by expressly stating that reasonable endeavours requires acceptance of non-contractual performance. Anyone considering this approach would be wise to carefully consider how such a provision would apply in practice, and to be clear as to what type of non-contractual performance they might be willing to accept.

First published in Accountancy Daily.