In this month’s update we:
- consider the FCA’s proposals for a new single listing segment for commercial companies;
- examine a case in which share valuation provisions were construed to give “good leavers” only nominal value for their shares; and
- explain how an unnamed party to a transaction could still find itself liable to the buyer
FCA discussion paper on listing reform: new single listing segment
The Financial Conduct Authority has published a discussion paper (DP 22/2) setting out its proposals for a new single listing segment for equity shares of commercial companies that would replace the current premium and standard listing segments. The discussion paper follows on from the FCA's consultation paper (CP21/21) on primary market effectiveness and Lord Hill's UK Listing Review, which set out a number of recommendations to reform the listing regime. Feedback on the discussion paper is invited until 28 July 2022.
To address concerns with the current listing regime (including its complexity, high costs and the barriers to entry for certain companies) the FCA has proposed a listing regime based on a single segment for equity shares in commercial companies where issuers would:
- list under a single set of eligibility criteria;
- be required to follow one set of mandatory continuing obligations;
- have the option of following an additional set of supplementary continuing obligations; and
- require a sponsor.
The FCA believes that if the new single segment is sufficiently flexible, the majority of companies will be eligible to list on it - companies would simply be denoted as having a "UK Listing" without segmental distinction. A single listing should also overcome concerns that a standard listing of equity shares is seen as inferior to a premium listing and lacks a defined purpose.
The proposed eligibility requirements for the new single segment are based on the current premium criteria and include the following:
- the publication of a prospectus including financial disclosure requirements such as audited accounts, working capital statement and complex financial history;
- a free float of 10% and a minimum market capitalisation of £30 million;
- the ability to comply with mandatory continuing obligations (see below);
- compliance with the current Premium Listing Principles; and
- the appointment of a sponsor.
In a major departure from the current premium listing regime, eligibility for the new single listing segment would not require the issuer to have a three-year revenue track record, three years of audited historical financial information, nor a "clean" working capital statement. Instead, investors would decide whether to invest based on relevant disclosures in the prospectus. This should provide an opportunity for high growth companies to obtain an earlier listing on the most "prestigious" listing segment.
Under the FCA's proposals, all continuing obligations in the existing Listing Rules would be recategorised as either mandatory or supplementary, with the mandatory obligations having to be met by all issuers listed on the new single segment. Issuers would decide whether to opt into the supplementary obligations during the IPO process.
The mandatory obligations would focus on transparency and protecting shareholders where the interests of management (or of a significant shareholder) may differ to that of ordinary shareholders. They would largely mirror the existing continuing obligations for premium listed companies and include:
- related party transaction requirements;
- the rules governing rights issues and open offers;
- pre-emption rights; and
- the comply or explain disclosures relating to corporate governance, climate change reporting and diversity and inclusion.
One notable exclusion from the mandatory obligations list is the "significant transactions" regime, which currently applies to premium listed companies. This means that shareholder approval would no longer automatically be required for transactions above a specified size or on a reverse takeover. Instead, the significant transaction rules, together with the rules on controlling shareholders and maintaining business independence would be included in the optional supplementary obligations list.
Issuers would be required to disclose in their Annual Report whether or not they have opted into the supplementary obligations and any change in that position would require prior shareholder approval.
As the single segment would primarily be for equity shares in commercial companies, there are some issuers and some securities that would not be eligible to be listed on it. As a result, the FCA is proposing to retain the standard listing segment for listings by SPACs, secondary listings by overseas companies, OEICs and also listings of securities other than equity shares.
Existing standard listed commercial companies would be permitted to retain their standard listing if they were unwilling or unable to meet the new single segment obligations. Those companies that were willing, however, would be required to satisfy an FCA eligibility assessment before stepping up to the new single segment.
Many market participants will welcome the FCA's attempts to make a UK listing a more attractive and more straightforward proposition for companies, particularly those in the high growth and innovation sectors.
The FCA believes that the creation of a single listing segment for commercial companies will resolve many of the disadvantages currently faced by those with only a standard listing. It remains to be seen, however, whether the proposed changes will reap any tangible benefits for listing applicants or for the London Market itself. This may depend, to a significant extent, on whether all "listed" issuers in the single listed segment will be eligible for inclusion in the FTSE indices or whether eligibility will be conditional on opting into the supplementary obligations. That is a decision to be made by the index providers and one in which the FCA has no control.
Failure to advise properly on allocation of sale proceeds was negligent
In Richards and another v Speechly Bircham LLP and another  EWHC 935 (Comm) the High Court found that a firm of solicitors had failed to properly advise two managers on a private equity-backed transaction about the impact on them of provisions relating to the allocation of sale proceeds.
In December 2014 the two managers sold their shares in a company to a private-equity backed newco. The managers each acquired a 30% holding of C shares in the newco and became the CEO and Sales Director.
Less than a year later, in July 2015, the managers were summarily dismissed from employment. Under the newco's Articles of Association this meant they were required to transfer their C shares and the price they would receive would depend on the circumstances in which their employment terminated: a "good leaver" would receive the market value of their shares, determined by an independent expert; but a "bad leaver" would receive only £1 in total.
The newco categorised the managers as bad leavers. The managers challenged that categorisation and in the related litigation (the leaver litigation) the judge found that they had been wrongfully dismissed. This meant they should have been categorised as "good leavers". As a result, the managers said they were entitled to the market value of their shares. But in the leaver litigation the judge found that they were only entitled to receive £1 for their shares. This was because of the impact of a "redemption premium provision" (RPP) on the calculation of the market value of the managers' shareholdings.
The RPP and the valuation provisions
The articles contained a ratchet provision that applied on a "Share Sale", defined as "the completion of any sale of any interest in any Shares (whether in one transaction or a series of related transactions) resulting in the transferee (either alone or together with its Connected Persons) holding a Controlling Interest in the Company").
The drafting of the ratchet meant that, if the sale proceeds were above two times the "Investment Amount", they were shared equally between the different share classes. But, if the proceeds were less than two times the "Investment Amount", then proceeds up to that amount would first be paid to the investor and the other shareholders would only receive any value for their shares after that payment and to the extent any proceeds in excess of that amount remained. This meant that the first c£11.5 million of any sale proceeds belonged to the investor.
The articles also provided that when assessing the value of a good leaver's shares, the independent expert had to determine the "market value of the Leaver's Shares at the Leaving Date as between a willing buyer and a willing seller as if the entire issued share capital of the Company were being sold in accordance with these Articles". The judge said that as the sale of the managers' shares would amount to a Share Sale under the articles, that meant the RPP applied. As the market value of the newco at the relevant date was less than two times the Investment Amount, that meant the managers got nothing for their shares.
The negligence claim
Having lost the leaver litigation, the managers then brought a claim against their solicitors on the basis that they had been negligent in failing to warn the managers that, because of the impact of the RPP on the determination of market value, even if they were classed as "good leavers" they would still receive no (or only nominal) value for their shareholding.
The managers said that, had they been made aware of this risk, they would (amongst other things) have concluded an agreement with another investor.
The judge found that, based on the evidence provided, it was more likely than not that the managers would have pursued an alternative deal with a different investor if they had been made aware of the above risk.
The judge awarded the managers damages of c£1.4 million for that loss of chance.
Interestingly, the judge in this case found that the judge in the leaver litigation had misconstrued the leaver valuation provisions in the articles. He said that actually the way in which sale proceeds would be distributed to the sellers under the RPP following a Share Sale was not relevant to the independent expert's determination of the market value of the managers' shares on a hypothetical sale of the entire issued share capital of the newco.
Whilst the judge agreed with the solicitors that the valuation provisions had been misconstrued, he still found that, because the drafting in the articles meant there was a risk of them being misconstrued in that manner, the solicitors had been negligent by failing to advise the managers of that risk.
Share sale: Non-contracting beneficial owner liable for misrepresentation
In Ivy Technology Limited v Martin  EWHC 1218 (Comm) the High Court held that the beneficial owner of shares, despite not being a party to the share purchase agreement, was still liable to the buyer for fraudulent misrepresentation (deceit). The buyer's related claim for breach of warranty failed, however, as it was clear from the terms of the agreement that the beneficial owner was not a contracting party and the buyer had been willing to proceed on that basis.
M and B each beneficially owned 50% of the shares in an online gambling business. They agreed to sell the shares to a trade buyer (Ivy) and an SPA was drawn up showing M (incorrectly) as the beneficial owner of 100% of the shares and stating that no other person had any right or interest in them.
During negotiations for the sale, Ivy was told that B wanted to remain "in the shadows." With the exception of one meeting attended by B in Prague, all transaction negotiations were fronted by M, and B did not otherwise communicate directly with Ivy.
Although Ivy was aware of B's beneficial interest in the shares, B was ultimately not named as a party to the SPA – it was entered into solely by M as the seller and Ivy as the buyer.
Following the sale, Ivy brought the following claims (amongst others) against M and B in relation to statements they had allegedly made concerning the profitability of the business:
- for breach of warranty in the SPA - with Ivy claiming liability against both M and B on the basis that M had given the warranties on his own behalf and as B's authorised agent;
- for fraudulent misrepresentations - made by both M and B at the Prague meeting; and
- for fraudulent misrepresentations - made by M during the course of the negotiations, with Ivy claiming that B was jointly liable as principal for M's representations due to M acting on his own behalf and as agent for B;
The key question in relation to B's potential liability was whether M had the authority to represent and make statements on B's behalf, and also whether M was authorised to bind B to the terms of the SPA.
B argued that M was not authorised to make fraudulent statements on his behalf, and if he did so, he was acting outside of the scope of his agency. B also denied liability for breach of warranty on the basis that he had never been a party to the SPA and any third-party rights or obligations under the SPA had been expressly excluded.
The Court ruled in B's favour in relation to the breach of warranty claim. Although M had breached warranties in the SPA, M was not authorised to enter into the SPA as B's agent and, therefore, B did not have any liability under the SPA.
If the SPA had simply failed to mention B, the Court might have concluded that B was a "disclosed and identified principal" whose obligations were not excluded by the terms of the SPA. This would have resulted in B being jointly liable with M for the breach of warranties. However, the Court found that it was clear from the SPA that B was not a party to it and, despite knowing that B owned 50% of the shares, Ivy was willing to contract with M alone for the entire share capital of the business.
In relation to the fraudulent misrepresentation claims, the Court ruled in favour of Ivy, finding that:
- both M and B had knowingly made fraudulent statements at the meeting in Prague; and
- M and B were also both liable for fraudulent misrepresentations made by M alone, as a result of M being authorised to make those misrepresentations on behalf of both himself and B.
As regards authorisation to make fraudulent statements, the relevant question was whether the agent was authorised to negotiate in relation to the transaction in question. If the agent was authorised, any statement made by the agent in relation to that transaction could be attributed to the agent's principal – in this case, that principal was B.
This case acts as a salutary lesson to a selling shareholder that they might still be liable to the buyer, even though they are not a named party to the transaction documents and neither have they been actively involved in the negotiations. Where an undisclosed buyer has an agent undertaking the negotiations on their behalf, the buyer will still be potentially liable for any misrepresentations made by the agent, including any made fraudulently.
From a buyer's perspective, the case illustrates the importance of ensuring that anyone who might be liable for breach of a contractual obligation is made a party to that contract or, at the very least, it should be made clear that the contracting party is acting as authorised agent for that person.
First published on Accountancy Daily.