In early 2017, the High Court invalidated the sale of a property by a company to one of its directors which had not been approved by the board, and a share buy-back with a deferred purchase price. The Court of Appeal has now confirmed that decision.
Dickinson v NAL Realisations (Staffordshire) Limited concerned a company that operated a foundry. The company had three shareholders – a Mr Dickinson (D), one of D’s family trusts, and a small pension scheme of which D was a trustee. D was also a director of the company, along with his wife and a third director, although in practice they never held formal board meetings.
Over several years, D entered into various transactions with the company, including the following:
- In 2005, he purchased a factory from the company for less than market value (the “factory sale”).
- In 2010, he, the family trust and the pension scheme sold shares back to the company (the “share buy-back”). The purchase price was left outstanding as a loan.
The company went into liquidation in 2013. The liquidators claimed that the factory sale and the share buy-back were invalid and sought a court order to recover the company’s property.
The High Court considered the issue and declared both the sale and the buy-back void and of no effect. D appealed to the Court of Appeal, but the court dismissed his appeal. We have summarised below the courts’ reasoning for striking down each transaction.
The factory sale
The High Court found that D had no authority to conclude the sale on behalf of the company. It was never approved in a formal board meeting, and D had not involved his co-directors in the decision.
D claimed the sale was valid because all of the company’s shareholders had approved it informally under the “Duomatic principle”. This principle provides that, if all of a company’s shareholders give their informal consent to something, that consent is as good as a formal resolution. But the High Court said it was not clear that all the pension scheme trustees had approved the sale. Alongside D there was a professional trustee, who had not been told about the sale, let alone consented to it.
On appeal, D claimed that the scheme had consented to the sale, because he and his wife were the only members of the scheme and they had approved it. The court disagreed for the following reasons:
- D and his wife were indeed the only members of the scheme, but they were not the only beneficiaries. D needed to show that all of the scheme beneficiaries had consented to the sale, but those beneficiaries included relatives and dependants, who had not approved it.
- In any case, there was no evidence that D’s wife had approved the sale. When cross-examined, she said she had not been aware of the sale. So even if the scheme members’ consent had been enough, that consent had not been given.
The High Court said the buy-back was invalid because the company had not paid for the shares when it acquired them. Under section 691(2) of the Companies Act 2006, when a company buys its own shares, it must pay for them at the time of purchase. Failure to comply with the Act renders a buy-back void.
Here the price was left outstanding as a loan. The judge rejected the idea that the loan arrangements themselves amount to “payment”, as the very purpose of the loan was to formalise deferral of payment.
On appeal, D argued that section 691(2) merely requires thebuy-back contract to provide for payment at the time of the buy-back, and it does not matter if the price is not in fact paid then. But the Court of Appeal said the words “paid for on purchase” in the Act were clear and required actual payment.
(The High Court also said the buy-back was void under section 423 of the Insolvency Act 1986 because it was made at an undervalue and its purpose was to put assets beyond the reach of creditors. However, having declared the buy-back void for lack of payment, the Court of Appeal did not consider this point.)
What does this mean for me?
The factory sale decision shows the importance of formally considering and approving transactions. Although this case revolved around unusual circumstances, the key issue was that the sale had not been approved by the board. Directors should bear the following in mind:
- All significant transactions should be approved by a company’s board, either in a board meeting or (if the company’s constitution allows it) by written resolution. This is particularly important if the transaction is with a director.
- If the transaction involves the sale of a non-cash asset above a particular value, it may require the approval of the company’s shareholders under section 190 of the Companies Act 2006.
- It may be worth obtaining shareholder approval for the transaction anyway to avoid claims that directors are acting in breach of duty.
It is also important to understand the limits of the Duomatic principle. As a general rule, it is not wise to invoke Duomatic to authorise a transaction up front. The principle has limits and, as this case shows, it can be difficult to show shareholder consent where pension schemes and trusts are involved.
But Duomatic can still be useful “after the event”, and this judgment emphasises that courts are prepared to look beyond legal ownership of shares when deciding whether consent has been given.
The share buy-back decision shows the need to structure share re-purchases properly. Failing to comply with statutory requirements will likely render a buy-back totally ineffective. In particular:
- The buy-back contract must require payment on purchase. It is possible to buy shares back in tranches, but payment for each tranche must be made when the shares are acquired. A company cannot pay for its own shares in instalments and payment cannot be deferred.
- In particular, shares must not be acquired in exchange for loan notes or loan stock. This is effectively an agreement to pay at a later time.
- That said, it should be possible in certain circumstances for a company to borrow money from the shareholder from whom it is buying the shares. However, the two arrangements must be structurally separate and not merely a sham to avoid having to pay on purchase.
Interestingly, the Court of Appeal (like the High Court before it) referred to the previous case of BDG Roof-Bond v Douglas and suggested that a company may be able to pay for shares by transferring non-cash assets. Although in that case the judge said that payment need not be in cash, most advisers take a conservative view and advise that there must be a cash price.
But in this decision, Lord Justice Newey specifically said: “[The] decision in BDG Roof-Bond Ltd … indicates that payment need not necessarily be in money.” This may well open the door further to non-cash share buy-backs, although in many cases it is possible to achieve the same result by entering into a separate asset sale transaction and setting the two arrangements off against each other.