Corporate Strategy & Finance Update, July 2007

In June 2007 the DTI published some updated interpretation information in the form of FAQ’s on those parts of the Companies Act 2006 (Act) due to be implemented on 1 October 2007. There were two items of particular note for those dealing with companies and their officers:

One of the most widely discussed parts of the Act is Part 10 entitled "A company’s directors" coming into force, with certain exceptions, on 1 October 2007. The exceptions listed in the implementation timetable included provisions relating to directors’ conflict of interest duties. The DTI has now made it clear that this exception is not limited to section 175 headed the "duty to avoid conflicts of interest", but also includes section 176 the "duty not to accept benefits from third parties", section 177 the "duty to declare an interest in a proposed transaction" and sections 182 - 187 which relate to the "duty to declare an interest in an existing transaction". These "conflict of interest duties" will not come into force until 1 October 2008.

This two-part introduction of the codified directors’ duties is to give companies time to consider what will constitute a conflict of interests for their directors and to amend their articles of association and directors’ service contracts accordingly.

From October 2007 directors will have to discharge the statutory duties of acting within their powers, promoting the success of the company, exercising independent judgment and exercising reasonable skill, care and judgment (ss 171 - 174 CA06). In addition directors will remain subject to the existing common law and equitable duties not to make a personal profit at the expense of the company by reason of their appointment as director and not to put themselves in a position where their interests conflict with those of the company. Further, the statutory duty under section 317 Companies Act 1985 to give a full and frank disclosure at meetings of directors of any personal interest in any contract or arrangement involving the company will still also apply. Company directors should by now be familiarising themselves with the new duties and code of conduct which they will be operating under from this autumn.

Not included in the original implementation timetable for October 2007, but which the DTI have said will be available to companies as they file annual returns made up to a date from 30 September 2007, are the new provisions relating to access to a company’s register of members: sections 116 – 119 of the Act.

The existing obligation on companies to maintain a register of members to be available for inspection remains, but there are two key changes: the Act prescribes information that any person requesting access to the register must provide to the company, and the request must be made for a proper purpose. Company secretaries must also note that the period for responding to a request for access has been reduced to five working days from the current ten days.

Every request for access to inspect or obtain a copy of the register of members must contain the name and address of the person making the request and, where a request is made by a person on behalf of an organisation, the name and address of that organisation. The request must also indicate the purpose for which the information is to be used, whether it is to be disclosed to any other person and, if so, the name and address of that other person and the purpose for which they will use the information. Within five working days of receiving such a request the company must either supply the information or apply to the court for directions that they need not supply the information as it is not being sought for a "proper purpose".

The Act does not indicate what will constitute a proper purpose and the DTI have said that it will be for the courts to determine. However it is likely that very strict criteria will be applied before directions not to disclose the information will be issued. The Institute of Chartered Secretaries and Administrators have published "Guidance on access to the register of members: the proper purpose test" which contains some examples of what would constitute proper or improper purposes and makes some best practice recommendations. The list of proper purposes includes a shareholder checking his own details or to contact other shareholders to exercise rights, checks on ownership as part of a transaction or requests related to a takeover offer or private acquisition or by a regulatory body. Examples of improper purposes include anything unlawful or for the purposes of commercial mailings.

Linked to these new provisions relating to access to information about a company’s members, but not coming into force until October 2008, is the part of the Act, Part 24, dealing with company annual returns. The Act does not specify that in future the annual return must include the member’s name and address. The required particulars to be included in the annual return are to be prescribed in regulations currently being drafted but not yet published. In a Written Statement made at the end of June the Government has said that public companies traded on EU regulated markets will only have to disclose the names and addresses (but not necessarily residential addresses) of holders of more than 5% of the issued shares or any class of shares of the company. For all other public and private companies the requirements will be changed so that it will not be necessary to disclose the addresses of members. The effect of such regulations would be that it may not always be possible to circumvent the ‘proper purpose’ provisions of the Act by searching at Companies House for details of the members of the company.

Companies are going to need to review their systems for dealing with requests for details of their registers of members in order to ensure that they have appropriate tests of what is a ‘proper purpose’ for the use of their information to apply to any requests received and systems that enable them to respond to the request or make an application to the court within the new, shorter response period. Consideration will also have to be given to their obligations under the Data Protection Act 1998 to avoid making any unlawful or unfair disclosure of personal data held by the company. Any party, for example a financier, who wishes to obtain information about a company’s members will need to ensure that its requests contain the prescribed information and are for a proper purpose. The Act introduces two new offences relating to requests for access to the register of members: to knowingly or recklessly provide information in connection with a request that is misleading, false or deceptive in a material particular; and to obtain information for or to permit it to be disclosed to another person knowing or reasonably suspecting that person will use it for an improper purpose.

The draft Companies Act 2006 (Commencement No 3, Consequential Amendments, Transitional Provisions and Savings) Order 2007 has been laid before Parliament. It provides for the commencement on 1 October 2007 of some of the key parts of the Act, including part of the statutory statement of directors’ general duties, derivative claims and proceedings, the business review and resolutions and meetings. [Click here to see Insight March 2007 for more details.]

At the end of June the DTI published its long-awaited guidance on the new statutory statement of directors’ duties. This takes the form of a collection of statements made by ministers during the passage of the Act as a bill through Parliament. These statements are extracts of the Parliamentary record chosen to assist in the interpretation of the codified duties. They cover the background to and effect of codification of directors’ duties, statements on specific duties, directors’ indemnities and the application of the general duties to shadow directors. Whilst concluding that directors’ duties are likely to evolve further over time, the primary message of the guidance is that save for a change to the common law procedure for dealing with directors’ conflicts of interest there are no major changes to directors’ duties under the Act. Included in the guidance is an eight-point plan for directors on how to comply with the duties. Copies are available from the Companies Act pages of the DTI website [http://www.dti.gov.uk/bbf/co-act-2006/] under ‘checklists and information’.

Pensions Act 2004 – first Financial Support Direction issued
Hammonds’ Human Capital (Pensions)

For the first time the Pensions Regulator has exercised its Financial Support Direction powers under the Pensions Act 2004 to protect the members of an under-funded pension scheme. In June 2007 the Determinations Panel of the Pensions Regulator ruled that Sea Containers Ltd should be subject to a Financial Support Direction to support its UK defined benefit pension schemes. Hammonds’ Pensions and Pensions Dispute lawyers advised the trustees of one of the schemes.

The "moral hazard" provisions are anti-avoidance measures introduced by the Pensions Act 2004 to ensure that employers properly fund and support their defined benefit pension schemes. A defined benefit pension scheme is one which promises to pay members on retirement a certain proportion of final pensionable pay for each year of pensionable service. The Financial Support Direction is one of these moral hazard provisions, the other being a Contribution Notice.

The Pensions Regulator can issue a Contribution Notice to an employer or others connected or associated with the employer, in situations where there has been a deliberate attempt (or act in good faith) aimed at avoiding pensions liabilities under a scheme. Payment of a sum up to the amount needed to buy-out the scheme liabilities can be ordered.

A Financial Support Direction may be made by the Pensions Regulator where the scheme employer is either a service company (meaning a company that provides services to other group companies and derives its turnover from that activity) or is insufficiently resourced (meaning that its assets do not exceed 50% of the estimated debt) and there is an associated or connected company against which it is reasonable to impose the Financial Support Direction. In considering whether it is reasonable to make a Financial Support Direction, the Pensions Regulator must consider the relationship between the scheme employer and the associated company, for example whether the associated company exercised control, and to what extent, over the scheme employer, what benefits were received by the associated company from the scheme employer and the associated company’s financial circumstances and involvement in the scheme.

A Financial Support Direction requires the recipient to make proposals for the financial support of the whole or part of the scheme employer’s pension liabilities and will remain in place until the scheme is wound up.

The use by the Pensions Regulator of the moral hazard provisions is seen by trustees, employer companies and financiers as a live issue in respect of financial covenants and credit assumptions of finance arrangements involving group companies where there are under-funded defined benefit pension schemes within the group and associated or connected companies with resources at least equal to the actual value of the scheme employer’s assets and 50% of the estimated shortfall of the scheme. This first exercise of the Financial Support Direction powers will be watched with interest by financiers and their customers.

At the end of 2006 a decision of the Court of Appeal in Churchill v First Independent Factors and Finance Limited (Churchill) caused consternation among those involved in the management of insolvent companies who are also involved in the management of the company that acquires the whole or a substantial part of the insolvent business.

Sections 216 and 217 Insolvency Act 1986 provide that a person who is a director of a company when it goes into liquidation may be personally liable for the debts of another company if he is also a director of that second company and it is known by a "prohibited name", meaning a name that is so similar to the name of the insolvent company as to suggest an association with it. However there are circumstances specified in rule 4.228 of the Insolvency Rules 1986 where the provisions of sections 216 and 217 will not apply; namely where a successor company acquires the whole or substantially the whole of the insolvent company through arrangements made by an insolvency practitioner appointed by the insolvent company who gives notice to the insolvent company’s creditors within 28 days of completion of the arrangements advising them (inter alia) of the circumstances of the acquisition by the successor company, the successor company’s name (where it would otherwise be a prohibited name) and naming any director of the insolvent company and that he is to be a director of the successor company.

The surprise in the Court of Appeal’s decision in Churchill was that the court held that to be effective notice under rule 4.228 the notice would have to be given before the person became a director of the successor company. In many cases where a business is sold by a company in administration the rule 4.228 notice is given, but following Churchill there would be no protection for directors involved in the management of the successor company and previously directors of the company in administration in the event that the first company enters liquidation within 12 months of the business sale.

Immediately following the decision in Churchill, the Insolvency Service announced that they would be amending rule 4.228 to remove the potential problems for directors stemming from the Court of Appeal judgment. The Insolvency (Amendment) Rules 2007 are expected to come into force on 6 August 2007. The draft new rule is now available on the Insolvency Service website:

http://www.insolvency.gov.uk/insolvencyprofessionandlegi slation/legislation/uk/amendmentsrules.doc

There is no change in the new rule 4.228 to the provision for a director of a company which goes into insolvent liquidation to act as a director of a company with a prohibited name where that company acquires the whole or substantially the whole of the business of the insolvent company, subject to compliance with certain notice requirements. One notable change is that unlike the previous rule, it will be possible for a person who was involved in the management of the insolvent company to carry on business under a prohibited name other than by way of a company, subject to the same notice requirements. The new rule expands the notice requirements as follows:

• Notice must be published in the Gazette and given to all creditors whose name and address is known to the director or could be ascertained by him on making reasonable enquiries.

• The prescribed notice may be given before the company enters into insolvent liquidation, for example where it is in administration or administrative receivership and may go into liquidation later. In cases where the company is not in insolvent liquidation, notice can be given where the director of the insolvent company is already a director of the acquiring company. However, notice must always be given before a director acts in a way that would be prohibited by section 216.

• The notice to creditors must be in Form 4.73 (which is a new form). In all cases the notice must state: (1) the name and registered number of the insolvent company, (2) the name of the director or shadow director, (3) that it is his intention to act (or, where the company has not entered liquidation, to act or continue to act) in any or all of the ways specified in section 216(3) in connection with the carrying on of the business of the insolvent company, (4) the prohibited name, or where the company has not entered liquidation, the name under which the business is being or will be carried on which would be prohibited in the event that the company goes into liquidation.

NOTE: the new rule 4.228 will only apply where arrangements for the acquisition of the business from the insolvent company are entered into on or after 6 August 2007. Where an arrangement has been completed before that date, the former rule will continue to apply.

Smoking at work ban –
Hammonds’ Human Capital (Employment)

From 1 July 2007 all enclosed public places and workplaces must be smoke-free. This follows similar measures already in force in Scotland, Ireland, Northern Ireland and Wales.

The new law means that it is unlawful to smoke in any "enclosed" or "substantially enclosed" premises or any "enclosed" vehicle used by members of the public or for work purposes by more than one person. Employers must display no-smoking signs in any premises or vehicles subject to the ban. The penalty for any employer in breach of the regulations is a fine of £2,500.

All employers must ensure that they have a no-smoking policy, with an appropriate disciplinary procedure for any breach by employees, and that their work practices comply with the new regulations. They must also inform their staff and visitors that all premises and vehicles must be smoke free and install appropriate signage.

In March 2007 the High Court ruled that that non-domestic rates are payable as an expense of the administration as a "necessary disbursement" under Rule 2.67(1)(f) Insolvency Rules 1986 (IR), in priority to payment of the administrator’s remuneration.

The changes to the administration regime made by the Enterprise Act 2002 saw the introduction of Rule 2.67 IR, which provides for the payment of expenses in the course of an administration and prescribes the priority of payment of those expenses ahead of the administrator’s remuneration. Although having many parallels with Rule 4.218 IR (which deals with the payment of expenses in liquidation) the administration expenses rule is less detailed. This has meant that since its introduction there have been several problems of interpretation and application for administrators when trying to determine whether a creditor’s claim constitutes an expense of the administration to which Rule 2.67 applies.

Re Trident Fashions PLC (Trident) is the most recent instance of the courts being asked to determine what constitutes an administration expense. The creditors in this case were a local authority seeking payment of non-domestic rates relating to retail premises occupied by the business whilst in administration. The court was asked to consider whether these rates were an "expense properly incurred by an administrator" (Rule 2.67(1)(a) IR) or a "necessary disbursement by the administrator in the course of the administration" (Rule 2.67(1)(f) IR).

Under the pre-Enterprise Act administration regime there was provision for the administrator to make payments in respect of contracts entered into by him in the course of the management of the company’s business. There was no provision for the payment of rates: the administrator had the power to make payment if he exercised his discretion to do so or if a court order for payment was made on the application of the local authority. In considering whether to make such an order the courts would take into account decisions relating to liquidation expenses but could also have regard to whether making the payment would jeopardise the interests of the administration as a whole.

In Trident the court determined that as Rule 2.67 IR was drafted in substantially the same terms as Rule 4.218 IR and after the House of Lords’ decision In re Toshuku Finance UK plc (2002) (where rates were held to be a necessary expense of a liquidation under Rule 4.218) it had been the intention when drafting Rule 2.67 that rates would also be an expense of an administration. As rates are a liability imposed on the company and not an obligation entered into by the administrator, the court held that rates were a "necessary disbursement" under Rule 2.67(1)(f) IR.

Applying the principles of payment of expenses in liquidation to rates incurred during an administration does, however, raise two problems: firstly there are statutory exemptions from liability to pay rates in respect of unoccupied premises available to liquidators that do not apply to administrators; secondly, unlike liquidators, an administrator cannot disclaim a lease and thereby terminate liability for rates. Further the judge did not consider that there would be any reason to distinguish between occupied or unoccupied premises when determining liability for rates.

The decision in Trident is going to have a significant impact on the distribution of administration assets to creditors whose debts do not fall within the classes of expenses. Unpaid rates can amount to substantial sums and, given the inability of administrators to take the same mitigating steps as a liquidator in respect of such debts, may make administrations less attractive to distressed companies occupying a number of premises. The decision also ends the possibility of administrators having the discretion not to pay rates where to do so would be contrary to the best interests of the administration and creditors as a whole. It was argued that this could also undermine the post Enterprise Act rescue culture.

Guarantees are widely used in commercial transactions to provide assurance to creditors that debts or other obligations owed to them are discharged fully in the event the principal debtor fails to perform. This assurance was shaken by the steps taken in early 2006 by PRG Powerhouse Limited (Powerhouse) to enter into a company voluntary arrangement (CVA) that contained proposals to release certain parent company guarantees given to landlords of premises being vacated by Powerhouse.

Powerhouse, an electrical retailer, was experiencing financial difficulties and decided to enter into a CVA with a view to preserving the future viability of the business. The CVA proposals included closure of a number of loss making stores, payment to the landlords of the abandoned premises amounting to a fraction of the rents that would have been payable if the leases were continued and the release from its obligations of Powerhouse’s parent company which had guaranteed payment of the rent to the landlords. The CVA further proposed to pay other creditors in full. The proposals were approved by the required majority of creditors and were immediately challenged by the landlords.

A CVA is a compromise agreement between a company and its unsecured creditors for a composition in satisfaction of its debts or a scheme of arrangement of its affairs. It is not possible to use a CVA to modify any rights of a secured creditor to enforce its security without consent or to alter the priority of payment of any preferential creditor, however Part 1 Insolvency Act 1986 which governs CVA’s does not contain any other provisions for the treatment of other creditors. There is no obligation to treat unsecured creditors equally, nor is there any provision for the treatment of guarantees. Guarantees do not create security interests against the debtor, but are merely contractual obligations of a third party to the creditor. If approved by 75% of the creditors by value present or represented at the creditors’ meeting and a simple majority of the members, the terms of the CVA will bind every person entitled to be at the meeting, whether or not present or in receipt of notice of the meeting, as if the creditor were a party to the CVA.

There are two grounds on which a creditor may challenge a CVA and seek its revocation, suspension or revision: that it is unlawful (ie there has been a material irregularity at a meeting) or that it is unfairly prejudicial to the interests of one of the creditors, a member or the company.

The landlords’ challenge in Powerhouse was that: firstly, the CVA was invalid or ineffective insofar as it purported to affect the rights of the landlords against the guarantor or constitute a release of the guarantees; secondly, it was unfairly prejudicial to the landlords’ interests having been voted for by creditors who would be paid in full whereas the landlords would only receive a partial payment and no compensation for the loss of the guarantees.

The long-awaited High Court decision was to have a significant impact not only in the commercial property market but also for all creditors holding guarantees.

The judge confirmed that as a CVA is a contract between a company and its creditors it could not affect any arrangement, such as guarantees, involving third parties; consequently the provisions in the Powerhouse CVA purporting to release the parent company guarantees to the landlords were not binding. However, the court did find that was possible for a CVA to impose on a creditor a requirement that it does not take any steps to enforce any rights against a third party (such as a guarantor) which if exercised would give the third party a right of recourse against the company (such as a right of subrogation against the principal debtor upon payment under a guarantee) as this would fall within the scope of the company’s arrangement of its affairs. Therefore Powerhouse could enforce a provision in the CVA against the landlords not to claim under the guarantees.

On the question of whether the Powerhouse CVA was unfairly prejudicial to the landlords, the court confirmed that there was no statutory requirement for a CVA to treat all creditors equally, there would be many situations where different treatment between creditors would be totally justifiable. The question of whether there is unfair prejudice between creditors in any case will depend on the facts: the court considered that in making a determination it would be necessary to compare both the position of the claimant creditor under the CVA with that under a liquidation or scheme of arrangement and the treatment of that particular creditor with that of the other creditors under the terms of the CVA.

In the Powerhouse case, the court found that the CVA was unfairly prejudicial to the landlords of the closed stores for a number of reasons, including: the landlords were put in a worse position by the release of the guarantees with no opportunity of negotiating with the guarantors and no compensation for the loss of value, the argued opportunity to re-let the properties was not accepted as valuable to the landlords; if there had been a liquidation of Powerhouse, the landlords would have been in a better position than under the CVA , not only would they have been able to claim under the guarantees but given the extent of the debts there would not have been any distribution for other creditors; the landlords were only to receive a fraction of their debt in order that the other creditors could be paid in full.

Whilst this decision provides some immediate comfort to the landlords in this case, other creditors of financially distressed companies holding guarantees in respect of the company’s debts and obligations should remain aware that Powerhouse leaves a loophole by which a creditor can be prevented by the terms of a CVA from making claims against a third party that could trigger rights of subrogation against the company where, on all the facts, the other terms of the CVA are not unfairly prejudicial to that creditor in contrast to the treatment of any of the other creditors.

This case was one of three heard together by the House of Lords which all principally concerned claims in tort for economic loss. The judgments were handed down in May 2007.

OBG Limited v Allan (OBG) involved a claim by the company acting by its liquidators against the administrative receivers. There had been a purported appointment of administrative receivers in respect of the company under a floating charge. It was subsequently claimed by the liquidators, and admitted, that the appointment was invalid: the floating charge being contained in a debenture that was assigned to creditors but which at the time of the assignment had no debt outstanding or secured by the charge. The creditors had attempted to attach an existing unsecured debt owed to them by the company to the empty debenture. The creditors had not in fact been entitled to appoint administrative receivers. However, until this point was raised and conceded, the administrative receivers believed the appointment to be valid and were found at all times to have acted in good faith.

In the course of their appointment the administrative receivers took control of all the company’s assets and undertaking and negotiated the settlement of various contractual claims. The claims against the administrative receivers were that they were strictly liable for trespass and conversion in respect of the land and chattels of the company and liable for wrongful interference with contractual relations in respect of the contractual claims or alternatively it was claimed that there had also been conversion of the contractual claims by the administrative receivers.

The House of Lords took the opportunity in this collection of cases to discuss at some length the economic torts argued before them, which they observed to be a difficult and unsatisfactory area of law in need of ‘tidying up’. The effect of the judgments is to narrow the application of the economic torts.

It was held that claims for interference with contractual relations could only be founded in one of two, separate causes of action, either:

• procuring a breach of contract - where the liability of the defendant is "accessory liability" depending on the contracting party committing an actionable wrong; or

• causing loss by unlawful means – where the liability of the defendant is "primary liability", the defendant has intentionally caused the claimant loss by unlawfully interfering with the interests of others.

The House of Lords found that the administrative receivers in OBG were not liable under either cause of action. There had been no breach or non-performance of the contracts that were the subject of the settlement negotiations and therefore no wrong had been committed to which accessory liability of the administrative receivers could be attached.

Nor was it found that the administrative receivers had either employed unlawful means or intended to cause any loss to the company in the conduct of their appointment, notwithstanding its invalidity. The House of Lords did not consider that there was a separate, general tort of unlawful interference with contracts.

The views of the House of Lords were strongly divided on the question of whether the tort of conversion could be applied to debts and contractual claims. The dissenting minority argued strongly the case for an extension of the tort to include economic loss, but the majority decision was that this was "too radical and fundamental a change" [per Brown LJ] and the tort of conversion should remain restricted to chattels. Accordingly the administrative receivers were only liable in respect of trespass to the land and conversion of the chattels.

The effectiveness of contractual restrictions on the assignment of contractual debts. By Peter Zonneveld, Butterworths Journal of International Banking and Financial Law June 2007 p 313

This article discusses the barriers to obtaining credit through the financing and trading of contractual debts where debtor contracts contain clauses prohibiting the assignment of the debts created by the contracts and makes suggestions for change.

The author argues for the benefits of increased liquidity, improved balance sheets and extended trade opportunities that can be obtained from receivables financing and securitisation which depend on the free assignability of contractual debts. The article considers the arguments in favour of non-assignment clauses: the importance of choice of contracting party, the preservation of rights of set-off under the contract and in the event of insolvency of the contracting party and certainty of good discharge in respect of any payment; and examines the current position under English law, which the author not only observes is confused but considers to be out of touch with modern commercial reality.

Taking the example of the US Uniform Commercial Code which provides that non-assignment clauses in contracts are ineffective, the author argues that any contractual provision that restricts the right of a creditor to collect the proceeds of the debts for a third party should be removed as a matter of public policy. The first step towards this was the controversial, and now postponed, draft reforms to the registration of security interests which included a proposal that in a contract between a company and third party giving rise to a receivable payable to the company a term purporting to prohibit or restrict assignment of that debt should not be effective against the assignee. The author concludes that there are compelling arguments for these changes.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.