How "certain" must a director transaction be for shareholder approval to be required?

The recent "summary judgment" litigation between MetalRNG plc and BriefENERGY Holdings LLP (and others) has provided some further clarity on what "is to be acquired" means for the purposes of the section 190 Companies Act 2006 ("CA")  bar on companies entering into arrangements with directors for the acquisition - by or from the directors - of a "substantial non-cash asset" (as defined in s. 191). The section, in general terms, allows a company to avoid and step away from the acquisition if the "arrangement" has not been approved by its members. In addition, whether or not the arrangement has been avoided by the company, the directors involved with the transaction (including their connected parties and those who merely approved the transaction) are liable to account to the company for gains they have made from it and to indemnify the company for any losses resulting from the transaction (subject to certain defences). 

Is to be acquired or may be acquired?

S. 190 catches "arrangements" entered into under which a "substantial non-cash asset" is acquired or is to be acquired and is designed to give shareholders protection against any "self-dealing" by their directors by allowing them to scrutinise the terms of the relevant acquisition before it becomes binding on the company. 

The courts have already considered whether the section, in applying to arrangements under which the company or director "is to acquire" an asset, catches arrangements under which the acquirer has no legal obligation to acquire the asset but can be expected to be likely to acquire the asset (presumably for commercial reasons). 

May be acquired is not sufficient

In Smithton Ltd v Naggar (2014) a company sought to make a director liable under s. 190 in respect of losses it had suffered on selling shares it had bought to hedge its position under CfDs it had entered into pursuant to arrangements with a director of its holding company (and so potentially within the ambit of s. 190). One of the arguments the company used to support its claim was that it was known that the director and his connected parties were interested in a possible takeover of the company whose shares had been bought, and so it should be considered likely that on the closing out of the CfDs, they would exercise their rights to acquire the shares themselves. In other words, the company had entered into an arrangement with the director or persons connected with him under which it could be said that the counterparty "was (at least likely) to acquire" a substantial non-cash asset (the shares). 

Both the trial judge and the Court of Appeal rejected that analysis of s. 190. As Arden LJ (as she then was) said - "there is no basis for interpreting the words "is to acquire" as "may acquire ... Since, when the arrangement was made for the CfDs to be written there was no certainty that on closing out the CfD holder would opt to acquire the referenced shares, s. 190 does not apply".

Conditional acquisitions v possible acquisitions

The recent MetalRNG litigation mentioned above involved a number of issues surrounding s. 190, one of which was how certain it had to be that an acquisition that a company had agreed pursuant to an arrangement with a director or connected persons, would in fact happen - i.e., is shareholder approval required for an arrangement under which a company or a director "is to acquire" an asset if there is some uncertainty as to whether the acquisition will in fact take place, e.g., an acquisition subject to conditions where one of the conditions may not be satisfied? Is there a difference between arrangements for what might be called "possible acquisitions" (per Smithton Ltd v Naggar) and "conditional acquisitions" (where a binding commitment is entered into to acquire an asset, albeit subject to conditions that mean the acquisition may or may not actually take place).  

In MetalRNG plc v BritENERGY Holdings LLP & Others (2022) (unreported though the judgment is currently available from the MetalRNG plc website via the hyperlink used above) the company entered into various agreements with a connected person of one of its directors under which it would purchase certain shares (the "SPA") and an option agreement under which the company was given the right to acquire further shares. The company sought to avoid or rescind these agreements on the basis that they had not received shareholder approval as required by s. 190. The counterparties argued that the agreements were not caught by s. 190 since they did not satisfy the requirement of being arrangements under which the company "is to acquire" the shares. 

The completion of the purchase of the shares was conditional under the SPA on FCA approval of a company prospectus and the option agreement was conditional on a successful listing of the third defendant and on the first defendant not exercising a right to terminate a related option. The defendants therefore argued that the arrangements lacked the "high degree of certainty" that they said, Smithton Ltd v Naggar required for there to be an arrangement under which the company "is to acquire" a substantial non-cash asset. 

Since the litigation involved a summary application by the company to enforce its claim for compensation against the defendants, the defendants needed to show that they had a real prospect of defending this claim at a full trial. The court (by a decision of a deputy insolvency and companies court judge) held that they did not. The judge held that the arrangements were clearly within s. 190 and should have been approved by a shareholder vote.  

Conditional obligations are caught

The judge held that the current case was fundamentally different from the situation in Smithton Ltd v Naggar. 

The SPA

To quote the judge: 

"Unlike Smithton Ltd v Naggar, the identity of the parties to the SPA, including the identity of the connected party who was to benefit from the agreement, the subject-matter of the sale, namely, the shares and the consideration to be paid for them were all identifiable with certainty at the time that the transaction was entered into. In my judgment, the phrase “is to acquire” in CA s 190 covers a situation such as the present case where a company is bound to acquire shares from a connected party, albeit that the obligation to do so is subject to the fulfilment of a condition.

It would drive a coach and horses through s. 190 to allow a party to side step it by simply inserting a condition into the relevant arrangement. Further, since the application of s. 190 (and so any required shareholder approval) has to be considered at the time the arrangement is made, it could not be argued that once the condition to the acquisition was satisfied or waived, shareholder approval would, at that stage, be required. The only condition that is permitted with respect to shareholder approval is what s. 190 expressly allows - that the entry into the arrangement is itself is conditional on shareholder approval".

The Option Agreement

So much for the SPA; as regards the option agreement, the defendants had three arguments why it was not caught by s. 190. The argument that it was a "conditional arrangement" failed for the same reason as it applied to the SPA. Their second argument was that the option agreement did not create any "right over property". It was a merely personal contractual agreement. Section 1163 defines "non-cash asset" as any property or interest in property other than cash, and, among other things, as including the creation of an interest in, or right over, any property.

Previous Scottish case law has held, however, that the statutory definition wording "extends beyond subsidiary real rights to subsidiary rights which, albeit personal, are capable of materially affecting the exercise by the other party of its proprietorial rights" and the Court of Appeal in another case, while recognising that some "personal rights" under Scottish law would constitute "real rights" (as in rights in real estate or equitable rights going beyond mere contractual rights) under English law did not disagree. (See Micro Leisure Ltd v County Properties & Developments Ltd (No. 1) (1999) and Granada Group Ltd v The Law Debenture Pension Trust Corp. plc (2016), respectively). 

The defendants argued that while an "unconditional" option agreement might create a "right over property" for the purposes of s. 190, a "conditional" option agreement would not. The trial judge could not see the basis for any such distinction, not the least because she found that the terms of the option agreement did materially affect (as in restrict the exercise of) the defendant's proprietary rights in the option shares.

The defendants' third argument was that the company had not shown that its right to acquire shares under the option agreement had a value in excess of £100,000 and so was a "substantial non-cash asset" and that therefore the company's claim was not capable of being determined by a summary judgment. The judge agreed that that value had not been shown but that did not matter since she found that the option agreement formed a part of a composite set of arrangements that included the SPA and the defendants had not denied that both the SPA and option together had a value of over £100,000. She rejected the defendants'' contention that whether all of the various agreements constituted one composite arrangement could only be determined at a full trial. All the agreements were drawn up as part of a renegotiation of the terms of an underlying transaction, they were settled, approved and entered into at the same time, and they cross-referred or were otherwise inter-conditional on each other. Further, the defendants had not produced any evidence that might suggest there were further matters that only a full trial could consider to determine whether or not the agreements constituted a single composite arrangement.

Takeaways

This recent litigation helpfully confirms the courts' determination to take a purposive approach to applying the "self-dealing" rule under s. 190. The company argued, ultimately successfully, that s. 190 is effectively a "tick-box" provision and that Parliament could not have intended that the need for shareholder approval under the section would be dependant on the directors' subjective evaluation of whether or not there was any certainty when the relevant arrangement was entered into that any conditions to it would be satisfied.

There is, in the courts' mind, a substantive difference between a company entering into an arrangement under which it subjects itself to some form of obligation to acquire (or dispose) of a substantial non-cash asset, even though that acquisition or disposal may not ultimately take place if certain "transactional" conditions are satisfied, and an arrangement under which the company or its director (or connected party) might be expected to proceed to acquire (or dispose) of an asset but without having any obligation to do so. The former clearly is subject to s. 190 and requires shareholder approval while the latter is not and does not.