Corporate Blawg UK

Parental guidance can be dangerous

Phillip Larkin, in "This Be The Verse", blamed his parents for being "fucked up" by them. To what extent may subsidiary companies look to their parent companies for this responsibility, and pass the buck up the tree? 
          For specific acts of a subsidiary there are certain remedies from the parent. For example, subsidiary companies (or their liquidators) may locate parental blame via a contract (e.g. by way of guarantee).  Also, liquidators may find parents directly liable for their subsidiaries' transactions at an undervalue, fraudulent or wrongful trading, or unlawful distributions, but these are all discrete misfeasances through which a liquidator may seek an (indiscrete) remedy.  Such events are slaps on the wrist compared to when a parent brings up their subsidiary poorly, encouraging hooligan behaviour and contempt for authority...
          It is oft a far greater fear of a parent company to be found to be a shadow director or de facto director of its subsidary.  Not only would the parent be personally liable for all the wrongs of the tear-away, but the longer-lasting effect may be the damage to the parent's reputation in the business community. 
          In sum, a "shadow director" is a legal entity/person who controls the company but is not officially appointed as a director (an officially appointed director is a de jure director); a de facto director is also not officially appointed but effectively sits on the board and is involved with decision-making.  The exact distinction between shadow and de facto directors has caused much debate in case law, and the rest of this post follows the most recent rulings:

           In Re Hydrodan (Corby ) Ltd [1994] 2 BCLC 180 the court decided that directors of parent companies are not automatically shadow directors of their subsidiaries.  Limiting options available to prosecution, the judge held that the case for a shadow dierctor as opposed to a de facto director would be mutually exclusive.  On de facto directors the judge said:

A de facto director is a person who assumes to act as a director. He is held out as a director of the company, and claims and purports to be a director, although never actually or validly appointed as such. To establish that a person was a de facto director of a company it is necessary to plead and prove that he undertook functions in relation to the company which could properly be discharged only by a director. It is not sufficient to show that he was concerned in the management of the company's affairs or undertook tasks in relation to its business which can properly be performed by a manager below board level.

The case of Secretary of State for Trade and Industry v Laing and others [1996] 2 BCLC 324 found that a company which is a shadow director does not automatically make the directors of that company shadow directors too.
           In Secretary of State for Trade and Industry v Tjolle [1998] BCC 282 the judge highlighted the grey scale, stating that being a de facto director was "very much a question of degree".  The court repeated some of the Hydrodan factors as "relevant" and added further factors to include: whether the individual used the title of director, whether the individual had proper information (e.g. management accounts) on which to base decisions, and whether the individual had to make major decisions.  The judge distinguished his analysis from Hydrodan by stating that it was key to ask whether the indvidual was "part of the governing structure"?  The reason for this is that there would be no justification for the law making a person liable for misfeasance or disqualification proceedings unless they were truly in a position to exercise the powers and discharge the functions of a director. 
          The Tjolle court's retention of its discretion was the last word to date on defining the de facto test.
          Of shadow directors, the Court of Appeal agreed with the definition in section 22(5) of the Company Directors Disqualification Act 1986 (Secretary of State for Trade and Industry v Deverell & Another [2000] 2 All ER 365).  In this case, the court held that:

1. The purpose of the legislation was to identify those (other than professional advisers) with real influence in the company's corporate affairs, but this influence did not have to be over the whole field of its corporate activities.
2. Whether a communication, by words or conduct, was to be classified as a "direction or instruction" had to be objectively ascertained by the court in light of all the evidence.
3. It would not be necessary to show the subservient roles of the properly appointed directors.
4. A person may be held to be a shadow director notwithstandiong that he took no steps to hide the part he played in the affairs of the company.

This last point is difficult to reconcile with the mutual exclusivity of de facto directors.  It suggests that the person/company may impliedly hold itself out as being a director, by not hiding the fact that he is behaving in such a way.  In this situation previous case law would find the legal entity to be de facto, yet Deverell suggests it could actually still be in the shadows. 
          In certain circumstances being a shadow director may be preferable to being a de facto director. Ultraframe v Fielding and Others [2005] EWHC 1638 (Ch) created a trade-off between shadow and de facto directors.  Whereas shadow directors could be liable for controlling all its subsidiaries' misfeasances, the definition of a shadow director is not wide enough to impose the same fiduciary duties as owed by the company's de jure or de facto directors.  However, the court held that a shadow director may be subject to specific fiduciary duties where his acts go beyond indirect influence.
          Corporate Blawg UK expects that the courts will cling to their discretion, in order to lift the coroprate veil when it is justified and appropriate to do so.  To reduce this risk, corporations can ensure they have clear and distinct management boards, and that all group companies can be seen to act independently of each other. 
          Despite the risks, large successful companies find parenthood hard to ignore.  It is unlikely that grown-up corporate entities will follow Philip Larkin's tongue-in-cheek advice:

Man hands on misery to man.
  It deepens like a coastal shelf.
Get out as early as you can,
  And don't have any kids yourself.

Green shoes and white collars = pixie

Like a pixie drunk on the nectar of Rhododendrons, stock prices may oscillate, plummet or shoot up and fly away. This is not always desirable for the human machinations that power the financial markets.  In certain circumstances, such as the issue of new shares, the fluidity of the capital market must be stabilised.  Such stabilisation manipulates the market, but is a "safe harbour" from penalisation for market abuse. 

          This manipulation may seem like financial black magic.  Yet the Financial Services Authority and other regulators justify it as necessary for promoting an orderly operation of the market, as well as reducing investor nervousness and preventing short selling.  Apparently, the market as a whole benefits, since investor security in the stability of securities encourages its use for capital gain.

         When a new issue of security (e.g. shares) is placed on the market, there may be an offer period during which those shares can be bought at a certain price.  Investors are less likely to purchase shares if during that offer period the share price greatly fluctuates. Therefore, it is helpful to stabilise the price. 

           On an issue of shares a stabilising manager (i.e. underwriter) may over-allocate the securities to investors to ensure that the entire issue is purchased (a bit like airplane tickets by flight companies).  The stabilising manager may increase the number of shares available if the demand goes up, and thereby stabilise the price before the end of the offer period.
          A Greenshoe is this market pixie which was discovered in the United States in an issue of shares for the Green Shoe Company.  It is essentially a call option which allows the stabilising manager to purchase an agreed number of extra shares in order to balance any short-fall as a result of over-allocation.  The agreed amount of extra shares is usually around 15% of the issue.

           This mechanism protects the stabilising manager from having to purchase shares that have risen above the offer price. However, the golden heel is that a green shoe does not come into effect if the market price falls below the offer price, as the stabilising manager may purchase his shares at this lower price.

           The stabilising manager usually exercises the greenshoe at the end of the stabilising period, just before the closing of the offer.  Some issuers prefer not to include greenshoe options where the issuer wants to fund a specific project with a fixed amount of cost and do not want any additional capital.

           The FSA appear uncharacteristically uncertain as to the meaning of "Refreshing the Greenshoe".  Corporate Blawg UK has interpreted the meaning as basically using the Greenshoe option more than once (e.g. by reselling the underwriter's Greenshoe stock and purchasing more shares under the call option).  Despite being unclear as to its meaning, the FSA has taken the view that selling securities which have been acquired through stabilising purchases can not be categorised as being in a safe harbour from market abuse accusations.  However, the FSA cowers behind the caveat that this does not mean that the behaviour is itself abusive and such sales should be constructed in a way to minimise market impact.
          For some bed-time reading, the Financial Services and Markets Act 2000 (Market Abuse) Regulations 2005 (S.I. 2005/381) contains the current price stabilisation rules, which came in to force on 1 July 2005.

Corporate Manslaughter - directors' duty of care

On 20 July, shortly before Parliament's summer recess, our representatives in the House were given the slim but potent Corporate Manslaughter and Homicide Bill to read on their gin palaces in the Med.  The bill is widely considered to have been long-time coming, and could not have come soon enough - public outrage has been justified at the major tragedies that have passed without punishment for the corporate entities that were ultimately responsible. 
          This new legislation is relevant to corporate lawyers, particularly in regard to due diligence, but also in relation to advising on directors duties and liabilities.
          Under current common law a company can be found guilty of corporate manslaughter if the director, who can be demonstrated to be the "controlling mind" of the company, can also be found guilty of gross negligence manslaughter himself. (P&O European Ferries (Dover) Limited [1991] 93 App R 72).
          The new Bill has significantly extends the duty of care to all corporate and some Crown entities working or performing services.  The duty of care will be owed by a company:

1. to its employees or to other persons working or performing services for it
2. as occupier of premises
3. in connection with: (i) the supply of goods or services (whether for consideration or not),(ii) construction or maintenance operations,(iii) any other activity on a commercial basis, or (iv) the use or keeping of any plant, vehicle or other thing

The offence is caused if the level of care exercised by senior management is a gross breach of the conduct that can be reasonably expected of the corporation.  This is intended to focus the offence on the overall way in which an activity was being managed or organised by an organisation, and to exclude more localised or junior management failings as a basis for liability.
          Senior management is defined as a person in control of the whole or a substantial part of the company, which is a lower threhshold than the "controlling mind" test.  Further, it is no longer necessary for senior management to have prior knoweldge, awareness or motives to be grossly negligent, merely the non-compliance with health and safety legislation will suffice.  Attitudes, policies, internal procedures, and health and safety guidance of a company may also now be taken into account by juries when considering whether a company has been grossly negligent.
           Special provisions and exemptions have been made for the emergency forces.  For the rest of the corporate world, financial penalties on summary conviction are now limitless. 
           The bill should become law around April 2007. 
           Corporate Blawg UK finds it somewhat bizarre that the Explanatory notes to the Bill proudly state:

It is estimated there will be 10 - 13 additional cases of corporate manslaughter/homicide a year following implementation of the offence. Costs of defending these are likely to be around £5 - 6.5 million. The costs of prosecution service preparation for these cases is expected to be £2 - 2.5 million and court costs are expected to be £0.1 - 0.2 million. However, because the offence is aimed at the sort of behaviour which would already be subject to prosecution (either under the existing law of corporate manslaughter or health and safety law), not all of these costs will be in addition to costs currently incurred both by defendants and the Crown. In addition there are likely to be savings as a result of fewer cases of corporate manslaughter failing at court which currently can result in large sums being awarded by the courts to defendants in respect of costs.

Corporate Blawg UK is intrigued that the new Bill also makes economic sense; and is not simply a bill to rectify a failing in the courts' ability to administer justice!

Phoenix companies

Founded in Egyptian mythology, the phoenix is a Garuda in sanskrit, a chariot of the Hindu God Vishnu, and had come to represent the Christian concept of resurrection.  This legendary bird that rises from the ashes is so widespread it appears in ancient Greek, Roman and Russian texts, on U.S. flags, and in company law textbooks.  It is this latter bird that interests us most...
           When a company enters into insolvent liquidation, its creditors (and anyone with a cause of action against the company) often lose out.  Since there is no money in the pot, all ties between creditor and debtor are burnt.  Following liquidation a phoenix company may arises and carry on the same business as had the insolvent company, often on the same premises and with the same or similar name (Re Linvale Ltd [1993] BCLC 654). 
           Stringent legislation and heavy penalties aim to protect creditors and the public from phoenix companies.  Where a company enters insolvent liquidation, any director of the company (who was a director in the 12 months prior to liquidation) will commit an offence if, within five years of liquidation, he or she becomes involved either directly or indirectly in the management of a company with the same or similar name (s.216, Insolvency Act 1986).  A director that is found to have committed an offence under s.216 will be personally liable for all the debts of the phoenix company (s.217).  Being a director of a phoenix company may amount to misconduct under the Company Directors Disqualification Act 1986, which provides for courts to disqualify directors for up to 15 years.  Contravention of a disqualification order may lead to a fine and/or imprisonment (s.13).
           On 10 June 2005, the Financial Services Authority (FSA) alerted financial advisers that it would be cracking down on phoenix companies, and not tolerate firms attempting to avoid their liabilities to customers by moving assets between companies. One year later, the FSA stated in its newsletter that it had had considerable success in stamping out phoenix companies over the previous year.  The FSA found that private warnings were an effective alternative to disciplinary action and that in order to keep the pressure on phoenix companies, it would further improve information sharing with the Financial Ombudsman Service and the Financial Services Compensation Scheme.  The FSA also issued a fact-sheet to assist firms to avoid being construed as phoenix companies when changing their legal status.

Addendum: a theory for the origin of the phoenix legend is that ravens and crows have been observed to sit on the fading embers of a fire and spread their wings.  As we enjoy a sauna or hot bath, so may crows enjoy standing on warm charcoal.  If a large raven on a fading fire were to flap its wings, it could bring the fire to life again. The new flames would almost certainly cause the bird to fly off, leaving a trail of flames and embers.

Scots Law vs English Law - commercial concepts

Although based in London, Corporate Blawg UK is very fond of Irn Bru, Edinburgh and Burns nights; and is never shy of Guinness, horse-racing or the Corrs.  In fact, Corporate Blawg UK is so proud of its celtic neighbours, that it finds it necessary to do more than just mention Scots Law in a passing fashion (and Northern Ire. law at a later date). 

          Aye-ccordingly, below are a few examples of key commercial law differences between Scots law and English (and Welsh) Law.  Comments on other significant differences in the company / commercial environment are most welcome: 

• Deeds do not officially exist in Scotland, although Scots will often refer to trust, tax and pensions documents as Deeds.  Neither does the English concept of "consideration" exist in Scots Law.   Scots contract law concerns the enforceability of the unilateral or gratuitous promise, which is intended to be legally binding without the need for acceptance.
• Unless otherwise defined, in England "joint" means that each will be liable for the whole loss and "several" means that each will be liable for any loss arising from his own performance. In Scotland "Joint" means that each is liable pro rata as a proportion of the whole of the loss, and "several" means each is liable for the whole loss.
• In England "representations" and "undertakings" may produce different remedies under common law (and/or the Misrepresentation Act 1967), whereas there are no such separate remedies under Scots law.  In Scots Law the term "warrants" will encompass both representations and undertakings.
• The concept of "full title guarantee" has no meaning in Scots law.
• Obligations cannot be assigned under English law, unlike Scots law were "assignations" may include obligations.
• Arbitration law is significantly different between the two jurisdictions. 

A high level difference between Scots law and English law occurs in relation to the implementation of EU law.  Once directives are adopted by the EU there is a period of time before those directives must be implemented in Member States.  This allows Member States to conduct consultations and review their domestic drafts to be effective and germane with the other laws of the Member State.
        For commercial and company law directives, the Department of Trade and Industry, or the Office of Government Commerce, will conduct consultations and reviews on behalf of the UK as a whole.  The UK Government will adopt the final version proposed by its agency.  The advantage for Scotland and Northern Irelandis that their own parliaments will conduct a further detailed review of the final draft regulations proposed for England & Wales.  Since Scotland and Northern Ireland will come to this legislation with relatively fresh eyes (and national pride) their amendments nearly always improve its consistency and clarity.  It is therefore common for EU legislation transposed into Scots law and Northern Ireland law to be better drafted than in England & Wales   
         This is analogous to the marketing situation whereby the business behind the market leader reaps certain advantages unavailable to the leader (like anarchists targeting MacDonalds rather than Burger King).  Scotland is like Burger King.

The Phantom Share Option Plan is here

Phantom stocks are the set number of shares in a phantom share option plan - not a topic to make a song or dance about, or a broadway musical.  Phantom share option plans are used by companies which cannot, or do not want to, offer employees options to acquire actual shares. 

          This type of plan is used to reward directors and executives for successful long-term performance.  The plan confers a right to receive a cash payment, where such payment is based on the increase in value of certain shares over a specified period. In many ways, a typical phantom share plan will reflect a real share option plan in terms and mechanism, yet without the right of participants to acquire shares.  If the director or executor does not meet the performance levels, their reward disappears in a puff of smoke.

          The accepted tax treatment of phantom share awards is equivalent to that of a share option.  In both plans, tax requirements are hidden at the grant of the award, but the action of payment of the cash reward unmasks the tax obligation. HMRC’s view is that participation in a standard phantom share plan does not mean that the employee has been granted an option, either under existing legislation or the proposed amendments.  However, HMRC's view is subject to the usual caveat of the need to consider variants on their own facts (on a case by case basis). 

          The 2006 the Budget expressly did not change the accepted tax treatment of normal phantom share awards.  Therefore phantoms will stay with us, lurking in executive offices and mysteriously disclosing themselves in annual accounts and remuneration reports.

         

Brief history of shares

Corporate lawyers know all about company shares - we know how to buy, sell, transfer, issue, divide, classify and capitalise them, and that's before we've got onto share options...  Yet, you would be hard pushed to find a corporate lawyer who knows the origins of shares.  Corporate Blawg UK has dug down to bring to you information that may dazzle your peers, amaze your friends and bore your clients.

• Corporations have existed since ancient Rome.  These enterprises, called etairia, were sanctioned by the state and involved a kind of shareholder who invested money for certain purposes.
• The main public corporation of ancient Rome was the municipium. Municipia combined the powers of ordinary corporations with the right of local government.
• The Roman concept of the corporation later merged with the views of Germanic tribes, such that a group entity could have a separate legal identity from its members.
• The early Christian church was a key corporate body.  Canon law determined that: the church would exist for longer than its members, officers could be liable for the acts of the corporation, and corporations could be liable for the acts of their agents (see further).
• In medieval Europe corporate entities ranged from the church, independent cities, guilds, and many charitable entities (such as hospitals).
• In 1111, the City of London Corporation became the first local authority in the UK.  The City Corporate was given a high degree of autonomy to reflect the fact that it was an important centre of finance and trusts.
• The oldest share certificate in the world belongs to Stora Kopparberg, or Stora Enso as it is now known (allegedly the world's oldest limited liability Company still in existence).   Stora Kopparberg issued its first share on 16 June 1288.
• The first public stock exchange was founded in Amsterdam by the world's first multinational; the Dutch East India Company. On 27 September 1602, the Dutch East India Company issued shares to the public in order to raise money.  These shares quickly sold, mostly at a nominal value of 3000 Guilders. The share price was not set by the government but by the Amsterdam Stock Exchange which was a profit-making and independent corporation itself.
• In 1844 the Joint-Stock Corporation Act created the modern form of commercial corporation in the UK.
• In March 2006, the global market capitalization for all stock markets was estimated at $43.6 trillion. 
• There are numerous free on-line games in virtual shares and virtual stock markets. This is not to be confused with virtual equity which may have real financial value since it is another name phantom stock (or phantom share options).

Gosh, so now you know.

Russian Roulette / Texas Shoot Out

The business world is highly inventive in its creative analogies and terms of violence to colour the black and white pages of corporate documents.  This week, Corporate Blawg UK has investigated a system for terminating joint ventures, where the two founding members of the joint venture are in deadlock over the vehicle's future ownership.

          The mechanism of "Russian roulette" is most commonly applied where each member owns 50% of shares and the primary purpose of the joint venture has been successfully completed. This mechanism commences with one member notifying the other member of its offer to sell to that member all its joint venture shares at a specific price.  This offer, in a deadlock resolution notice, must then be accepted; otherwise the declining member is obliged to sell all its own joint venture shares to the offeror at the same price.

          A variation of this mechanism may be described as " Texas shoot out" (or "Mexican shoot out", depending on whether your prefer mescal to mesquite).  A Texas shoot out is also most common in a 50:50 joint venture.  The process involves both parties submitting a secret and sealed bid to a third party.  The party with the lowest bid crumples in agony (and fills its pockets with cash) as it must sell its shares to the higher bidder at the higher price.  In the case of Banner Homes Group plc v Luff Developments Ltd and another [2000] 2 All ER 117 a "Texas shoot out" was understood to mean an arrangement under which either party could offer put and call options at a specified price or prices which the other could accept or refuse.  This would suggest a more flexible procedure, where negotiation would get the best price for the purchased shares.

          Naturally, the precise mechanism and procedure behind these terms should be clearly defined in the agreements in which they are used.  Corporate Blawg UK would not recommend using any complex terms in a contract without detailed explanation of how they work.  However, Corporate Blawg UK would like to see more cool terms creeping into contracts of the future.  Corporate Blawg UK is currently developing three corporate and commercial mechanisms of its own, in order to describe them as a: "Ferrari 600 clause", "A Golden Goal clause" and a "clause of Mass Destruction"

Case spotlight: Re Duomatic

Re Duomatic LW [1969] 2 Ch 365 is a shining beacon of pragmatic common law.  The case lights a path through the murky legal landscape of administrative irregularities in company procedures.  Members of a company may informally and unanimously agree to override procedures designed to protect minorities.  For example, a public company may make written resolutions instead of special resolutions, despite there being no provisions for written resolutions by public companies in the Companies Act 1985.

          The effects of Re Duomatic have been refined by Re Barry Artist Ltd [1985] 1 WLR 1305, where the court held that it was reluctant to allow a written resolution to replace a special resolution in the preparation for a reduction of share capital.  Due to the specific circumstances of this case the court did allow the written resolution to be effective, but expressly stated that the case should not be followed.  The reason given for this distinction was that the reduction of a company's capital, unlike the amendment of articles of association for example, is not a matter for the company alone - the court has discretion to confirm or refuse to confirm it (s.136 of Companies Act 1985).  Nourse J pointed out, most pleasantly:

Why should the court confirm it if it is done in some other way, however effective it may be? Moreover, if the reduction is confirmed the minute cannot, as is at present proposed in this case, refer to a special resolution which has not been passed. It will have to refer to a written resolution of all the members, which is something which may cause confusion and uncertainty amongst those who are not versed in the niceties of company law.

More recently in this line of legal logic, Re Torvale Group Ltd - [1999] 2 BCLC 605 distilled the essence of Re Duomatic to be where the members of specified group (prescribed by statute or articles) require a prescribed procedure for certain courses of action, and those members all agree to the course of action, the prescribed procedure is no longer necessary.  

          It may be tempting to use the Re Duomatic principle to avoid the administrative burden of holding meetings or obtaining the proper prescribed resolutions.  Such deliberate contravention of the rules could damage the reputation of the company, create difficulties for future investors and/or be part of a maladministration claim by officious shareholders. Corporate Blawg UK expects that the courts would not look favourably on deliberate uses of the Re Duomatic principle.  However, the principle does exist and has been applied by the court on numerous occasions. Corporate Blawg UK would be interested to hear of any experiences of this principle being used prospectively?

Unfair terms made easy

Currently each a slave to two masters, commercial lawyers will rejoice at the news that the Law Commission has produced a draft bill amalgamating both the Unfair Contract Terms Act 1977 ("UCTA") and Unfair Terms in Consumer Contracts Regulations 1999 ("UTCCR").
          For 6 years, commercial contract lawyers have carefully laid their anti-negligence bread-crumbs as they negotiated their way through the twists, turns, traps and pitfalls of inconsistent and repetitive legislation.  UCTA and the UTCCR continue to confuse and obfuscate with different languages and concepts producing effects that are similar but not identical.
          Within UCTA alone there is conflict, for it contains two Parts: one for England & Wales and Northern Ireland, and one for Scotland. The two Parts have almost the same effect but use different languages (says the Law Commission report)! As between the legislation, UCTA applies to a small range of contracts and is designed to control only exclusion clauses; and UTCCR covers a much wider range of terms, extending to all terms but subject matter or price.
          To silence the baying agony of commercial lawyers' contorted neurons, the Law Commission has produced a draft bill which:

1. extends to all the terms;
2. continues to exclude liability limitations for death or personal injury, or basic requirements of quality and fitness for purpose;
3. includes negotiated clauses as well as standard clauses; and
4. in claims brought by consumers, ensures the burden of proof lies with the business.

These proposals do not significantly change the current regime, yet small business will be dancing in the street (with commercial lawyers) if the draft is accepted by parliament.  By their lesser bargaining power and tighter margins, small business may be forced into unfair contracts, sometimes simply in order to survive!  Such unfair terms in unfair contracts may be permissible in law as they are standard terms in business-to-business contracts.

          No more must small business suffer in this way - the draft Bill includes special protection for “micro businesses” which are businesses with nine or less staff. These micro businesses will be able to challenge any standard term unaltered by negotiation, or that is not the subject matter or price.  Exceptions to this are contracts for financial services, contracts over £500,000 and situations where the apparently small business is associated with other businesses to create a group with more than nine employees.

          The Law Commission calls for a well-resourced organisation to use preventive powers to protect small businesses. The Law Commission notes that such resources are currently unavailable.  Corporate Blawg UK believes that instead of the DTI using tax-payers money to set up new quangos, the DTI should encourage small businesses to seek professional legal advice in regard of contractual matters.