Legal updates: August 2014

In our monthly round-up of legal cases, Gateley LLP experts consider the right to invoke voting restrictions in JKX Oil & Gas and the Charterhouse ruling on drag along provisions

A case revolving around voting restrictions highlights the use of s793 notices. A public company has the ability to serve a notice (known as a s793 notice) on anyone it reasonably believes is in some way interested in its shares. Using this power, a company is able to discover the identity of its beneficial owners who may be hiding behind those who are registered as holding the legal title to the shares. Failing to respond to a s793 notice is a criminal offence and can result in the company applying to court for restrictions on the relevant shares. However, the articles of association of most public companies also contain sanctions which the company can impose itself in these circumstances. Typically this includes preventing the affected shares from being used to vote at any general meeting.

In Eclairs Group Ltd v JKX Oil & Gas plc [2014] EWCA Civ 640, the board of JKX Oil & Gas served s793 notices on certain people requesting information about the beneficial owners of the company’s shares and the arrangements between those owners. The board believed the responses to those notices failed to adequately disclose the required information and therefore invoked the provisions in the company’s articles preventing the legal owners of the shares from voting at the upcoming agm.

At first instance, the court found that the disenfranchisement of the shares was invalid. The court held that in invoking the voting restrictions the board had been motivated by a desire to prevent the resolutions proposed at the agm from being voted down (they were aware that the relevant shareholders intended to vote against those resolutions). This was an improper use of those powers which actually could only be used in order to compel the relevant parties to provide the information requested in the original s793 notices.

However, this decision was overturned (by a majority) when the Court of Appeal took a purely mechanistic approach to the relevant provisions. If the board had reasonable cause to believe that the required information had not been provided, then they were entitled to invoke the voting restrictions and their reasons for doing so were irrelevant. There was no ‘proper purpose’ test when considering the board’s actions.

Comment: This case potentially gives companies with concerns about voting at their agm the ability to disenfranchise shares by serving s793 notices and hoping that the shareholders fail to comply with them (although, obviously, if they do comply, their shares cannot be disenfranchised). It is worth noting, however, that the shareholders have been given leave to appeal the question of the board’s purpose to the Supreme Court, so it would be sensible to wait and see what happens before relying on this decision to attempt to obtain a tactical advantage over a hostile shareholder.

Case report: drag along provisions in Charterhouse

Arrangements between shareholders are often drafted to include ‘drag along’ provisions enabling majority shareholders to require minorities to join in a sale to a third party. In this way, a troublesome shareholder cannot block a potential sale or hold the majority to ransom.

Since a company’s articles of association can be amended with the consent of 75% of the shareholders, it is theoretically possible to insert drag along provisions into articles without the agreement of all the shareholders. However, to be valid, this power of a majority to amend articles which then bind a minority has to be exercised fairly and in the best interests of the company as a whole. This is a subjective test: provided there are reasonable grounds on which the majority could consider the change to be in the company’s best interests, the amendment will be valid.

This test was applied in the recent case of Re Charterhouse Ltd [2014] EWHC 1410 (Ch) in which the articles of association of the private equity firm Charterhouse were amended to include majority drag along provisions. Those provisions were then used to force a shareholder to sell his shares against his wishes.

When Charterhouse was originally formed its shareholders had all been members of its investment management team. However, over time executives had left but been allowed to retain their shares. Evidence was heard that this misalignment of interests would be an impediment to Charterhouse raising a new fund.

The solution was for those shareholders who were current members of the investment team to form a new company, which then offered to acquire the shares in Charterhouse.

The offer was conditional on certain amendments being made to Charterhouse’s articles. All the existing shareholders bar one accepted the offer and the drag along provisions in the amended articles were used to acquire the shares of the dissenting shareholder. The dissenting shareholder claimed that the drag along provisions had been used to acquire his shares at an undervalue, rather than for any genuine commercial reason.

Applying the test outlined above, however, the court held that the amendment to the articles was in the best interests of Charterhouse and therefore the drag along provisions could be used to force the dissenting shareholder to sell his shares.

Comment: There are some specific factors which may make this decision of limited use when considering subsequent cases. In particular, the misalignment between the company’s shareholders and its management team was causing Charterhouse significant problems which, according to expert evidence, were particularly relevant in the private equity industry. In other industries or sectors the consequences of such a misalignment may not be so severe.

In addition, the drag along provisions were effectively aimed at a number of non-continuing shareholders, although in fact most of them accepted the buyer’s offer without needing to be ‘dragged’. While the buyer was a vehicle formed by some of the existing shareholders, this was not a case where a drag was being used as a mechanism to remove a lone troublesome shareholder, with all the remaining shareholders continuing in business together without him.

The reorganisation was necessary in order to secure the long-term stability of Charterhouse when it was agreed that a sale to another buyer, or a cash injection from another investor, was unlikely. The case may therefore be less persuasive in a situation where a company has alternative viable options for its future.

Finally, and most significantly, the existing documents to which the dissenting shareholder was a party already contained drag along provisions and the court viewed the changes made to the articles as a ‘tidying up exercise’.

Since drag along provisions were part of the original commercial bargain between the founder shareholders and the dissenting shareholder, he was not in a position to complain about being forced to sell his shares at a price accepted by a majority of the other non-continuing shareholders. The case may therefore be of little help where the parties wish to insert drag along provisions where none have previously existed.

Employment law: breaches of contract

If an employer fundamentally breaches the contract of employment, employees are entitled to resign as a consequence and claim they have been constructively dismissed. However, one of the fundamental principles of claiming constructive dismissal is that an employee should not leave it so long between the employer’s breach of contract and the resignation that it is deemed the breach has been waived. Resigning after the point that the contract has been affirmed will mean that employees have no claim as they have just resigned rather than having been constructively dismissed. But how long does the employee have? This was the key issue in the recent case of Chindove v William Morrisons Supermarket plc UKEAT/0201/13/BA.

Mr Chindove allowed six weeks to pass between the act he relied upon as the employer’s breach of contract and his resignation. Morrisons argued that this was so long that he had to be taken to have waived the breach, so defeating his own constructive dismissal claim. The Employment Appeal Tribunal held that there is no set period of time after which the employee will be deemed to have waived the contract. All the circumstances have to be taken into account, particularly whether the employee has conducted themselves in such a way that affirmation of the contract can be implied. It followed in this case that, as Mr Chindove had been off sick for most or all of the six week period, the delay alone could not really be held against him.  

Comment: In relation to general guidance it was suggested that an important factor could be whether the employee has complained or not and whether their personal circumstances could explain the delay. If the employee’s family is dependent on their job as their only income, if they have been in it for many years and if it would be difficult to find other employment, it would be reasonable to expect that considerable thought be put into the decision of whether to quit or not before communicating the decision to the employer. There could, therefore, be a delay without waiving the breach.

Employment: excessive notice affirms contract

Once notice of resignation has been given, could it still be possible for an employee to affirm their employment contract? This was the issue highlighted in the case of Cockram v Air Products plc UKEAT/0038/14/LA.

Mr Cockram had complained about his manager’s conduct but the subsequent investigation concluded that there was no substance to his grievance. In response Mr Cockram resigned. His resignation letter made clear that he was resigning in response to what he considered was a breach of trust and confidence, but rather than giving three months’ notice as his contract required, he gave seven months’ notice. When his employment eventually came to an end, his claim of constructive unfair dismissal was thrown out.

It was held that in giving notice well in excess of that required by his contract of employment Mr Cockram was offering additional performance of his contract to that which was required. His actions had affirmed the contract even though it was after notice had been given.

Comment: Resignation in response to a fundamental breach of contract will allow the employee to resign on notice or with immediate effect. Mr Cockram had been caught out by giving too much notice. The decision shows that, in these unusual circumstances, post-dismissal affirmation is a real risk for the employee. If he had given just the contractual period of notice or even less, there would have been no question of affirmation.

Employment contracts: working your notice

In cases where any breach of an employment contract is in dispute, employees who resign without giving the required contractual notice are at risk of themselves being in breach of contract. The consequences were shown in the case of Tizhen Li v (1) First Marine Solutions Ltd (2) Dan Moutrey UKEATS/0045/13/BI.

Miss Li was the principal engineer responsible for an important overseas business project. Her contract of employment provided that she would need to give one month’s notice of resignation. It was also stated: ‘If an employee leaves, without working the appropriate notice, the company will deduct a sum equal in value to the salary payable for the shortfall in the period of notice.’

Miss Li resigned but failed to attend work during her notice period. In response the employer deducted £5,000 – her full month’s salary – from the other monies due to her (not including her notice pay).

Miss Li claimed that the employer had no right to take these monies as the clause was a penalty and unenforceable. She lost. It was held that the employer was entitled to withhold the money as this was a genuine pre-estimate of loss. It had to be taken into account that she occupied a key role in an important contract. Her sudden departure meant a replacement had to be engaged urgently and that was going to incur expenditure.

Comment: The judge observed that a better construction of the clause might be to set out that entitlement to payment for the notice period would be conditional upon the employee actually working the notice. This would have meant that no deduction would have been made from other monies due to the employee. Given these comments, if a clause is intended to create a liability on the employee to make a payment, the wording should perhaps refer to the amount as being a ‘genuine pre-estimate of loss’.

Women on boards milestone reached

With the recent appointment of Patrice Merrin to the board of mining and commodities firm Glencore Xstrata plc, for the first time in its history the FTSE 100 no longer has any boards consisting solely of men.

Following the Lord Davies review of women on boards in 2011, the government adopted an approach of self-regulation rather than imposing set quotas. The UK Corporate Governance Code now requires quoted companies to include in their annual reports a statement of their policy on diversity, including gender.

In addition, changes made to the narrative reporting regime mean those companies must also disclose details of their boards, senior management and wider workforce broken down by gender.

In his third annual report published earlier this year, Lord Davies confirmed that significant progress had already been made by the FTSE 100 towards achieving the collective target of 25% female representation. At that time, there were still two FTSE 100 companies with all-male boards. Merrin’s appointment is therefore a significant milestone on the road towards greater gender diversity in boardrooms.

Legal updates by Sophie Brookes and Christopher Davies of Gateley LLP


Sophie Brookes |Partner, Gateley plc

Sophie Brookes is a partner and professional support lawyer in the corporate team at Gateley plc. Her over-reaching responsibility i...

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Christopher Davies |Associate and professional support lawyer, Gateley plc

Christopher Davies is an associate and professional support lawyer at Gateley plc, and has specialised in employment law for 20 year...

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