Article / 1 Sep 2024
In this month’s update we:
In Literacy Capital Plc v Webb [2024] EWHC 2026 the High Court considered a restrictive covenant in an investment agreement and found that it was unenforceable as it was too widely drafted and lasted too long.
In 2014 a doctor founded a company that provided medical services to sexual assault referral centres (SARCs) operated by the police. The company did well and in 2018 the founder sold a controlling interest to an investor. The founder received some consideration upfront with the balance left outstanding via a loan note which would be repaid on a long stop date or on an earlier sale of the company.
The founder remained with the company until 2021 when she resigned and renegotiated the sale of her shares which, by then, were worth around £7m. The investor and the founder entered into a new investment agreement and the original loan note was replaced by one which would be redeemed in 2028 (subsequently extended to 2030) or an earlier sale. The loan note carried interest at 7% per annum (around £500,000), which would cease if the founder breached the restrictive covenants in the investment agreement. Those covenants included:
After resigning, the founder set up another business. Following the end of the 12 month ex-employee non-compete restriction, the new business began to provide services that were competitive with those supplied by the company. In particular, it won a tender for providing SARC services to South Wales Police.
The investor brought a claim for an interim injunction to prevent the founder, via her new business, trading in competition with the company in breach of the longer restriction, linked to the loan note which the founder continued to hold.
The judge confirmed that, as the restrictive covenant was in restraint of trade, the starting point was that it would be unenforceable unless the investor could prove that it was reasonable. When assessing what was reasonable, the Court would consider the areas of trade or services restricted, the geographical area covered and the duration of the restriction.
In this case, the judge found that the restrictive covenant was void and unenforceable as it was too widely drafted and applied for too long a period. In particular:
As a result, the covenant went far beyond protecting the investor’s legitimate interests in acquiring the company and protecting the goodwill in that business.
This was a decision on an interlocutory injunction application so it did not involve a full trial on the facts. As the judge noted, this is not generally the stage for analysing the reasonableness of restrictive covenants. However, he concluded that, exceptionally and on the facts of this case, it was appropriate to rule that there was no arguable issue about the covenants’ lack of validity.
Following swiftly on from the new UK Listing Rules becoming effective, the FCA has now published a consultation paper (CP24/12) setting out its proposed rules for a reformed UK prospectus regime. The proposals, which are arguably less radical than the listing regime changes, aim to reduce the costs of listing on UK markets, make capital raising in the UK easier, and remove barriers to retail participation.
In January 2024, the Public Offers and Admissions to Trading Regulations 2024 (the Regulations) became law, providing the framework for a new UK public offers and admissions to trading regime. The Regulations will replace the current UK Prospectus Regulation when they come fully into force.
Under the Regulations, an offer of securities to the public will be unlawful unless an exemption applies. Although many of the current prospectus exemptions will be carried over, the Regulations include an important new exemption that applies when securities are to be admitted or are already admitted to trading on a regulated market or to a primary multilateral trading facility (MTF), such as AIM.
In another significant change, the Regulations delegate to the FCA the detailed rule-making powers for the new regime. These include the power to set rules on:
As part of this rule-making process, the FCA has now published CP24/12, which sets out its detailed proposals for when a prospectus is required and the content requirements for any prospectus. The FCA’s rules must be implemented before the new regime can become fully effective.
This article considers the key proposals for companies seeking to admit equity securities to a UK regulated market or to a primary MTF.
In relation to admission to a regulated market (such as the Main Market of the London Stock Exchange), the FCA is intending to broadly replicate the existing prospectus regime, but with some additional relaxations. The revised rules will be set out in a new “Prospectus Rules: Admission to Trading on a Regulated Market” sourcebook, which will replace the current Prospectus Regulation Rules.
A prospectus will continue to be required for an IPO on a regulated market. However, in a major change for secondary capital raises, the FCA is proposing to increase the threshold below which a prospectus will not be required, from 20% of the issuer’s existing share capital to 75%. Issuers will be allowed to publish a voluntary prospectus below this threshold. This change should exempt many issuers from the requirement to publish a prospectus and make it significantly easier and cheaper to raise capital in a secondary fundraising.
The FCA is proposing to relax the requirements for a prospectus summary. Detailed financial information will no longer have to be included and issuers will be able to cross-refer to other sections of the prospectus. The page limit for a summary will also increase from seven to ten pages.
The requirement to include a working capital statement in a prospectus is to be retained, but the FCA is seeking views on whether to allow issuers to disclose significant judgements and assumptions made in preparing the statement.
Where an issuer has identified climate-related risks as risk factors, or climate-related opportunities as being material to the issuer’s prospects, the prospectus will have to include additional sustainability disclosures about how the issuer is managing the relevant risks and opportunities.
The consultation includes the FCA’s proposals for which types of forward-looking statements should qualify as “protected forward-looking statements” (PFLS). These PFLS will have a different liability threshold based on fraud or recklessness (rather than the current threshold of negligence.)
Under the current regime, where an IPO involves an offer to the public, the prospectus must be published at least six working days before the end of the offer. The FCA is proposing to reduce this period to three working days with the aim of encouraging issuers to include a retail offer in their IPO.
In another significant change, the FCA is proposing that primary MTFs that allow retail participation – such as AIM – must require the publication of an “MTF admission prospectus” on all initial admissions and reverse takeovers (with exceptions for existing simplified routes to admission).
Although these MTF admission prospectuses will not need to be approved by the FCA, they will be subject to the same statutory responsibility and compensation provisions as apply to regulated market prospectuses. Operators of primary MTFs will determine the relevant prospectus approval and content requirements and will also have discretion as to whether a prospectus will be required for secondary issuances.
The introduction of an MTF admission prospectus is likely to be welcomed by companies wanting to make a retail offer on AIM. The ability to include retail investors without the need for an FCA approved prospectus will be an attractive option and should increase retail participation in AIM IPOs.
The FCA’s consultation closes on 18 October 2024. Subject to consultation responses, the FCA aims to finalise the new prospectus rules by the end of H1 2025, with full implementation shortly after.
The Court of Appeal has confirmed that the identity of a company’s members is to be determined by the entries in the company’s register of members at the relevant time. In the absence of rectification, this principle will apply despite a person’s name having been wrongly removed from the register as a result of forgery or fraud (Bland v Keegan [2024] EWCA Civ 934).
Every company is required to keep a register of its members and that register must contain specified information, including the number and class of shares that each member holds.
A person will become a member of a company when they agree to be a member and their name is entered on the register of members. (Subscribers to the company’s memorandum of association will automatically become members on the company’s registration.) The register of members is “prima facie” evidence of a company’s membership.
Where there is an error in the register of members, an application should be made to the court for rectification of the register. However, in the absence of any dispute, directors can correct minor mistakes in the register without applying to court.
Directors need certainty as to the identity of a company’s members, not least to ensure the validity of shareholder resolutions. Resolutions that have been passed as a result of the votes of non-members are open to challenge and are potentially void.
The issue before the Court of Appeal was whether the liquidators of a company had been validly appointed by a special resolution signed by the purported sole member of the company (Julie).
The validity of the resolution had been disputed by the Appellant in the case, who alleged that Julie had fraudulently executed a stock transfer transferring the Appellant’s 50% shareholding in the company to Julie. The Appellant claimed that as the transfer of shares was void, the special resolution was also void because Julie only held 50% of the company’s shares (rather than the required 75%).
Although the company’s register of members could not be found, the Court assumed that the register would have reflected filings made at Companies House showing the unauthorised transfer (and, therefore, Julie being registered as the sole member of the company).
The Court of Appeal dismissed the appeal, finding that the special resolution appointing the liquidators had been validly passed.
The Court confirmed the fundamental principle that “except where express provision is made to the contrary, the person on the register of the members is the member to the exclusion of any other person, unless and until the register is rectified.” This principle applied for the purposes of voting on a shareholder resolution “even in a case where a member’s name has been wrongly removed from the register as a result of forgery or fraud.”
On that basis, the only member of the company entitled to vote on the special resolution was Julie.
It may seem unfair that a shareholder can lose their rights as a member of a company due to the unauthorised or even fraudulent transfer of their shares. However, as confirmed in this case, the Court has the power to undo the effects of any misconduct by ordering rectification of the register and the payment of compensation to affected parties.
A Court will have discretion as to whether any rectification order should have retrospective effect. If the Appellant had applied for (and won) such an order, the special resolution would not have been passed by members holding at least 75% of the shares, and the outcome of this case could have been very different.
First published in Accountancy Daily.
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