Are your pre-emption rights on a share transfer water tight?

Do you have a “change of control” clause in your shareholders’ agreement? Are your pre-emption rights on transfer of shares comprehensively drafted?

If not, the recent UK case of McKillen v Misland (Cyprus) Investments Limited involving the back-door takeover by the Barclay brothers of Coroin Limited, the entity that owns the famous London hotels Claridge’s, the Connaught and the Berkeley, should be a wake-up call for a review of your joint venture /shareholders’ agreement and articles of association.

Facts

The Barclay brothers wanted to acquire Coroin Limited (Coroin) but could not reach an agreement with one of its major shareholders, Partick McKillen (McKillen). The Barclay brothers subsequently obtained control of Coroin, not by acquiring shares directly in Coroin which would have been in breach of the pre-emption provisions in the company’s articles of association (Articles) and Shareholders’ Agreement, but by acquiring ownership of the shares in Misland (Cyprus) Investments Ltd (Misland), a shareholder in Coroin.

McKillen brought an action for unfair prejudice and as part of that claim there was a trial of a preliminary issue namely whether such a transfer was contrary to the pre-emption provisions of Coroin which restricted the transfer of shares or any interest in those shares.

McKillen argued that the pre-emption provisions in the Shareholders’ Agreement and the Articles required a transfer notice to be served in the event of the sale of shares in a shareholder of Coroin. The Shareholders’ Agreement specifically provided that:

“no Share nor any interest therein shall be transferred, sold or otherwise disposed of save as provided in this clause”.

The phrase “any interest therein” should in McKillen’s view include the sale of a shareholder of Coroin and the sale of Misland to the Barclay brothers should therefore be held to be in breach of the pre-emption provisions.

Decision

The judge dismissed McKillen’s claim and made it clear that a principle applicable to pre-emption articles under English law is that as the right to deal freely with a share is an important attribute of ownership and prima facie right of a shareholder, the existence and extent of any restriction on transfer, such as pre-emption rights, must be clearly stated:

“Commonly used phrases in pre-emption provisions have distinct legal meanings and superficial small variations can have significant legal effects.  This is relevant consideration when construing pre-emption provisions, particularly when as in this case they are complex and have been professionally drafted, using and adapting well known standard provisions.”

The case makes it clear that pre-emption right provisions must expressly contain:

(i)            restrictions on transfer of shares to prevent legal title being transferred; and

(ii)           restrictions on transferring or creating any interest therein to prevent beneficial interests being transferred outside the pre-emption provisions.

In addition, if the pre-emption provisions only restrict the above they do not prevent the sale of the shares in a shareholder itself that holds such shares in the joint venture company (JvCo).

“Such a sale involves no change in the shareholder’s legal and beneficial ownership of the underlying shares in the JvCo nor evidences a desire to transfer those shares or any interest in them.”

“Any interest therein” does not include indirect interests such as those it could be said arose by ownership of shares in the shareholder who held the underlying shares in the JvCo.

From the terms of the relevant shareholders’ agreement it was clear that the JvCo was a vehicle for a venture between a restricted number of shareholders who had personal rights to appoint directors.  The pre-emption provision was supposed to preserve the personal nature of the venture.  However, the lack of an express change of control provision allowing the pre-emption provisions to apply on the change of control of a shareholder in the JvCo meant this intention was not met leading to a rather unsatisfactory outcome for Mr McKillen.

The judge further stated that articles of association have a special status as a “statutory contract” adopted pursuant to the UK’s Companies Act, requiring public registration and being capable of amendment by special resolution.  By reason of these provisions, the court has no jurisdiction to order rectification of articles or set them aside on grounds of misrepresentation.

He also held that extrinsic evidence is not admissible in the construction of articles.  This is because the articles govern relations between the company and its members and between the members.  Members are a fluctuating body of persons.  Persons become members on the basis of registered articles and without in most cases any knowledge of the circumstances existing when the articles were adopted or subsequently amended perhaps on many occasions.

Conclusion

If you don’t suddenly want to find yourself in partnership with a stranger make sure you have comprehensive pre-emption rights containing:

– Restrictions on transferring shares to prevent legal title being transferred;
– restrictions on transferring or creating any interest therein, to prevent beneficial interests being transferred outside the pre-emption provisions;
– a restriction on a transfer of voting rights; and
– an express change of control provision so that pre-emption rights cannot be circumvented by a sale of shares in the shareholder you went into business with originally.

Janice Wall
Cil van der Merwe