A recent High Court decision, Paros plc v Worldlink Group plc  EWHC 394 (Comm), contains lessons in clear drafting as well as a useful reminder that amendments to one section of an agreement may have consequences elsewhere, intended or otherwise. Awareness of the rule against financial assistance, a key issue in this case, is important for international parties considering transactions involving public companies in the UK.
Paros and Worldlink entered into a heads of terms for a possible reverse takeover of Worldlink by Paros in February 2009. At that time Paros was a public limited company (PLC) listed on AIM, the Alternative Investment Market of the London Stock Exchange. Having sold its business in March 2008, Paros was treated as an “investing company” for the purposes of the AIM Rules and therefore required to enter into a reverse takeover within 12 months to avoid suspension and eventual de-listing. By early 2009, its financial predicament was serious and a number of potential transactions had fallen through.
Worldlink, also a PLC but unlisted, owned through a subsidiary a number of patents relating to mobile transfer and updating of data, with significant potential value if infringements by handset manufacturers could be established. That value had not been exploited and Worldlink had limited resources, prompting the company to pursue an AIM listing to access working capital.
The heads of terms included the following:
- a non-binding agreement for Worldlink to re-register as a private limited company;
- a non-binding agreement for Paros to acquire the entire issued share capital of Worldlink (defined as “the Acquisition”);
- a binding 90-day exclusivity period, during which Worldlink could not negotiate with any other party for the acquisition of its shares or assets; and
- a binding commitment by Worldlink to pay Paros’ costs and expenses.
The general obligation to pay Paros’ costs and expenses was followed by two additional sentences, stating that
(i) between signing and Worldlink re-registering as a private company, Worldlink was to pay a break fee of £12,500 per week, capped at £150,000, if it refused to proceed with the Acquisition; and (ii) after re-registering, Worldlink was to pay Paros’ costs in relation to the Acquisition, unless Paros withdrew from negotiations without cause, in which case each party would bear its own costs.
A few days later, the parties agreed orally to vary the heads of terms such that Paros would acquire Worldlink’s assets rather than shares in the company. As time passed, Worldlink sought advice in relation to other options that might be available to it to raise working capital and, shortly before the expiry of the exclusivity period, entered into discussions concerning a possible reverse takeover with another AIM company. Around the same time, Paros appointed a firm of stockbrokers to act as its nominated advisor in connection with the acquisition of Worldlink. In the end, Worldlink did not re-register as a private company and eventually withdrew from the negotiations in October 2009. Not long after, Paros entered into a company voluntary arrangement (a compromise with its creditors).
Paros sued Worldlink, claiming over £700,000 for its expenses and damages for non-payment of its expenses, breach of the exclusivity provision and negligent misstatement. Worldlink asserted that because it had not re-registered as a private company, it would have been liable under the heads of terms only for the break fee of £150,000 but, because the break fee constituted financial assistance under s.151 of the Companies Act 1985 and was therefore void, it was not liable for Paros’ expenses at all.
Construction of the heads of terms
The key issue of construction of the heads of terms was whether the change from a share sale to an asset sale meant that the cap on the break fee no longer applied so that Worldlink would be liable for all of Paros’ expenses.
Paros’ counsel argued that only the general obligation survived; that the parties’ “core agreement” was for Worldlink to pay all of Paros’ expenses. The specific sentences concerning the capped break fee and the obligation to pay expenses after re-registering as a private company were included purely to avoid the rule against financial assistance (discussed below) and if the share acquisition did not proceed, these sentences “were not engaged”.
The court held that the variation of the heads of terms a week after it was agreed did not affect the construction of the costs provision of the agreement in this way. The first sentence containing the general obligation for Worldlink to pay Paros’ expenses did not stand alone and was supplemented by the sentences dealing with the capped break fee and the post-re-registration costs. Although the parties changed what was meant by “the Acquisition” under the heads of terms, they did not choose to amend the costs provision and it was not for the court to impose such a change when the words of the heads of terms were clear and unqualified. The more specific provisions which followed Worldlink’s general obligation to pay Paros’ expenses, evidenced what had been agreed by the parties in relation to Paros’ expenses for the Acquisition, regardless of whether the Acquisition was of shares or assets. Since Worldlink did not re-register as a private company, the second specific sentence was not triggered, and Worldlink’s liability to Paros was therefore limited to paying a break fee of £12,500 for each week following the signing of the heads of terms, with a cap of £150,000.
Was the break fee financial assistance?
Background to Financial Assistance
The parties structured the break fee clause in the heads of terms to avoid the rule against financial assistance. The rule was first enacted in the late 1920s and has evolved over time with the aim of preventing buyers using the cash or assets of a company to fund the acquisition of that company, with obvious consequences for creditors and minority shareholders. In its present form in the Companies Act 2006, the rule broadly provides that it is unlawful for a UK PLC whose shares are being or have been acquired (or for any of that company’s subsidiaries) to give financial assistance for the purposes of that acquisition or proposed acquisition, with certain exceptions. A UK PLC also cannot give financial assistance for the purposes of the acquisition or proposed acquisition of shares in its private holding company, again unless certain exceptions apply. A breach of these provisions is an offence attracting criminal penalties for the company, its directors and officers. Directors of the company can also be liable for breach of their fiduciary duties to the company.
“Financial assistance” is not exhaustively defined in the legislation, but includes assistance given by way of a gift, by way of guarantee, security or indemnity (other than in respect of the indemnifier’s own neglect or default), by way of release or waiver, or any other financial assistance given by a company so as to reduce its net assets by a material extent or where it has no net assets. In Paros, the court determined that the provisions of the heads of terms dealing with costs and expenses were an indemnity in respect of those liabilities.
Until October 2008 the prohibition applied to private as well as public companies, although by following a statutory “whitewash procedure” (broadly consisting of statutory declarations of solvency from each of the directors, an auditors’ report and a special resolution of the shareholders of the company), private companies could give financial assistance for the acquisition of their shares. The whitewash procedure had to be used extensively in leveraged buy outs to enable security to be granted by the target for the acquisition funding and to have the target pay the LBO team’s fees. The elimination of the complex structures, time and cost associated with the whitewash procedure has simplified private equity deals. However, the prohibition on giving unlawful financial assistance still applies to UK public companies and private companies giving assistance for the acquisition of their PLC parent company, and these cannot be “whitewashed”.
Analysis of Financial Assistance
In any analysis of whether financial assistance is being given, the starting point must be the “commercial substance and reality” of the transaction (Chaston v SWP Group plc  EWCA Civ 1999, Arden LJ, paragraph 38). The question to ask is whether the agreement – in this case, for Worldlink to pay a break fee – “smoothed the path to the acquisition of the shares” (Chaston, paragraph 38). Although a break fee is payable if the transaction does not proceed, the words of the statute make it clear that the prohibition applies to a person “proposing to acquire” shares equally as to a person acquiring shares, regardless of whether the transaction is completed. The assistance is given at the time the liability is assumed, not when a payment is made, because that is when liability is assumed by the company or its net assets are impaired.
The court in Paros held that at the time the heads of terms was entered into, the agreement for Worldlink to pay the break fee did “[smooth] the path” to the acquisition. If Worldlink withdrew from the transaction before it re-registered as a private company, Paros was assured of receiving at least a portion of its costs and expenses for the transaction, and the court also noted that the provision for an amount of £12,500 per week was clearly based on Paros’ likely costs for the transaction. It was apparently not disputed that the break fee would have materially reduced the net assets of Worldlink, which were negative at the time (although, note that the court also held that the promise to pay the expenses was an indemnity and therefore would have been financial assistance whether it reduced the giver’s net assets or not). The binding commitment to pay the break fee therefore amounted to the giving of unlawful financial assistance.
The break fee was unlawful while Worldlink remained a public company negotiating with a potential buyer of its shares. However, the court concluded that the unlawfulness of the break fee provision (in the unvaried heads of terms) rendered the provision unenforceable, rather than void as if it had never been made. Within a few days of entering into the heads of terms, the parties agreed to vary the form of the Acquisition so that Paros would acquire Worldlink’s assets. The break fee clause, in the court’s analysis, was therefore reinstated or rendered enforceable and Paros was entitled to payment of the capped amount of the break fee of £150,000, plus nominal damages of £4 in respect of its other claims.
Incidentally, the agreement to pay Paros’ costs and expenses after Worldlink had re-registered as a private company was not unlawful financial assistance, because the obligation to pay would arise only if that condition were satisfied, upon which it would be lawful for Worldlink to pay.
When dealing with the acquisition of a PLC (or its related private companies, see above) parties and their counsel should closely analyse whether any break fee would constitute financial assistance and be unlawful (note that other issues may also arise, including under the UK Listing Rules and the Takeover Code). Since private companies are no longer prohibited from providing financial assistance, re-registration may be an option. Alternatively, as in Paros, structuring the transaction as an asset sale may be a suitable alternative, although an asset sale is likely to give rise to other complications, including tax.
Although Paros concerned only companies located in the UK, from an international deal-doing standpoint it is important to note that a UK PLC cannot give financial assistance for the purpose of an acquisition of shares in its private holding company, regardless of where that company is located. So, for example, a grant of security over the assets of the PLC to secure the buyer’s financing for the acquisition would be caught by the rule. For private companies, although the prohibition and the whitewash procedure have been repealed, it remains important for boards to take into account all relevant considerations when determining whether it is appropriate to give financial assistance.
Finally, the Paros case contains useful insights into the drafting and construction of the binding and non-binding parts of the heads of terms. The parties’ agreement that Worldlink would pay Paros’ (capped) expenses before Worldlink re-registered as a private company was unlawful and the payment of the expenses would have been void had they not then agreed to vary the Acquisition from a share sale to an asset sale. However, the variation did not affect their commercial agreement that Worldlink would have a capped obligation to pay Paros’ expenses before re-registration and this became enforceable when it ceased to be unlawful. Paros clearly shows that where the parties want to vary their agreement, attention should be paid to every provision of the contract, not merely the obvious ones. As the court suggested, the parties were free to tear up the heads of terms and enter into a new contract; that they did not do so meant that they would be held to their bargain.