The High Court in Mr Desmond Gunewardena v Conran Holdings Limited [2016] considered the position where an incorrect version of the company’s articles of association had been filed at Companies House.
Background
Conran Holdings Limited (CHL) was the holding company for various businesses of Sir Terence Conran, the well-known designer and restaurateur. CHL was formed in 1993 and Mr Gunewardena, who was then a finance director in Sir Terence’s businesses, acquired shares in CHL. Mr Gunewardena later became CEO of CHL and held a 7% shareholding.
In 2006, the restaurants were transferred to CGL Restaurant Holdings Ltd (CGL), in which CHL had a 51% shareholding and Mr Gunewardena and others had 49%. Mr Gunewardena ceased to be an employee and the CEO of CHL and became an employee of CGL.
In 2013 Mr Gunewardena and a private equity house acquired CHL’s 51% in CGL. CHL claimed that this event gave rise to a deemed transfer notice of Mr Gunewardena’s shareholding in CHL in accordance with CHL’s articles of association because he was no longer employed by the CHL group. The form of those articles of association and, in particular, the method of share valuation included in the transfer provisions, was the basis of the dispute between the parties. On 1 December 2014, Mr Gunewardena’s shares were compulsorily transferred to CHL because he has ceased to be employed by a member of the CHL group. CHL applied a method of valuation which valued Mr Gunewardena’s shares at nil.
Mr Gunewardena argued, firstly, that the event required to trigger the compulsory transfer provisions had not occurred on the true construction of the articles and, secondly, that even if it had, the true articles entitled him to a valuation based on a fair value as determined by the auditors, which would have valued his shareholding at over £3million.
A brief history of the articles of association
1993
CHL’s articles adopted in August 1993 provided that pre-emption rights would apply if an employee ceased to work for the company or a subsidiary and the employee would be deemed to have served a share transfer notice. The price payable for the shares was as an amount certified by CHL’s auditors as being a fair selling value between a willing vendor and a willing purchaser (the Fair Selling Valuation).
1995
In October 1995, the articles were amended to provide that the value on transfer was to be calculated by reference to five times the average annual profit of the last two accounting periods (the Five Times Profits Valuation). The amendments also gave the CHL the right to be offered shares when shares were transferred in accordance with the pre-emption rights, subject to satisfying the statutory requirements.
1998 and the wrong articles filed
In March 1998, the articles were further amended to create a new class of shares. Due to a drafting error, the version of the articles subsequently filed at Companies House did not reflect the 1995 amendments and so omitted the Five Times Profits Valuation and left in place the fair selling valuation (the Filed Articles).
Once the mistake became apparent later that year, a special resolution was passed by the shareholders adopting a correctly amended version of the articles (including the Five Times Profits Valuation), but this version was not filed (the Corrected Articles).
The two versions and their contrasting share valuations
CHL relied on the Corrected Articles and, given that there were losses in each of the two relevant accounting periods, the Five Times Profits Valuation resulted in a valuation of nil for Mr Gunewardena’s shares. CHL nevertheless paid £1,254 to Mr Gunewardena for his 7% shareholding, being the par value of the shares.
By contrast, the Filed Articles would, it was claimed by Mr Gunewardena, have resulted in a valuation of over £3 million on the basis of the Fair Selling Valuation.
Issues to be determined by the high court
The key questions before the court included:
- Was CGL a subsidiary of CHL immediately prior to the ultimate sale of CGL in 2013? This was key in determining whether the compulsory transfer provisions were engaged.
- Which were the true articles of association of CHL and were they the true articles by virtue of their filing? This was key to determining the basis of valuation.
- If not, were the filed articles the true articles of the company by virtue of agreement between or acquiescence by the Shareholders?
Analysis by the high court and decision
Was CGL a subsidiary?
For accounting purposes, despite CHL having a 51% shareholding, CGL was treated as a joint venture company rather than a subsidiary in CHL’s accounts, due to the contractual arrangements between the shareholders, including CHL. Mr Gunewardena argued that, in consequence, when he became CEO of CGL in 2006, he ceased to be an employee of the CHL group. The compulsory transfer provisions in the Articles could have been invoked at that time but were not.
CHL argued that CGL ceased to be a subsidiary of CHL in 2013 when CHL disposed of its 51% shareholding and that transaction triggered the compulsory transfer provisions in the articles. The articles incorporated the statutory definition that a company is a subsidiary if it holds a majority of the voting rights.
The court dismissed Mr Gunewardena’s argument as it failed to distinguish between what ‘subsidiary’ meant for the purposes of the articles and the label to be applied in CHL’s consolidated accounts. For the purposes of the articles, CGL was a subsidiary of CHL until the sale of the balance of CGL’s shares in 2013. Mann J highlighted the importance of construing articles of association as at the date they came into force, stating that:
“The meaning of the words in the Article[s] cannot change according to changing circumstances; they cannot change by reference to how certain people regarded a relationship; and they cannot change depending on how accounting standards (which might themselves change over time) might view the situation.”
The articles did not define ‘subsidiary’ by reference to UK accounting standards; they defined it by reference to the Companies Acts. Mr Gunewardena therefore ceased to be an employee of the CHL group in 2013, at which point he gave a deemed transfer notice of his shares.
Which articles were the true articles?
Mr Gunewardena argued that the articles have to be registered and when registered they take effect as a statutory binding contract, referring to the ‘sanctity of the register’ and relying on Scott v Frank F Scott (London) Ltd [1940] which refers to the significance of registration and that it is the form that is registered and no other that becomes binding on the members.
The court distinguished that case and rejected this argument because it fails to distinguish between the articles as a contractual or legal concept and the articles as a piece of paper designed to capture or evidence that concept. It also over-states the significance of registration.
There is nothing in the statutory scheme which vests the Filed Articles with the special quality of being the real articles for all purposes. The articles are what the members have resolved on from time to time, whether originally or by amending special resolution. Nothing else can be the articles. Their status as articles does not depend on registration.
The printed form is a record, either accurate, or inaccurate. It does not achieve ‘sanctity’ by being filed at Companies House. Statute makes the articles amendable only by special resolution, not by misplaced filing. Filing the articles is a statutory obligation on the company and its officers. If the right articles are filed the obligation is fulfilled; if the wrong articles are filed, the obligation is not fulfilled.
The Corrected Articles, as resolved by special resolution of the members but not filed, were therefore the true articles of CHL.
Adoption by acquiescence
Mr Gunewardena, relying on a decision of the Privy Council in Ho Tung v Man On Insurance Company Limited [1902], argued that the Filed Articles were acquiesced in and acted upon by all shareholders after they were filed and they thereby become binding. The court viewed this as really an application of the Duomatic principle.
The evidence did not support this argument. When it was discovered that the incorrect articles had been filed, the company’s solicitor had sent a special resolution with a copy of the correct version to all shareholders for signature. Two shareholders failed to sign the resolution but that did not necessarily connote dissatisfaction with the resolution or preference for the Filed Articles. So far as the other, signing, shareholders were concerned, the fact that they signed demonstrated their consent and their preference to correct the mistake. The court regarded this as an expression of their view that the Five Times Profits Valuation was the form to be preferred. Accordingly, the acquiescence argument failed.
There was no case for saying that the shareholders agreed, or acquiesced in, the fact that the Filed Articles were those governing CHL. Again, the true articles were the Corrected Articles.
Comment
The case confirms that filing the articles of association of a company at Companies House does not have the magical effect of making the relevant form the articles of the company, if that form does not accurately record the effect of amendments made by special resolution of the members. The meaning of the articles cannot change in accordance with changing circumstances.
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