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The rule is essentially a judge-made rule, almost as old as company law itself, derived from the fundamental principles embodied in the statutes by which Parliament has permitted companies to be incorporated with limited liability. Ratio |
Mummery LJs reference to ultra vires must be understood in the wider and looser sense of the term identified in Rolled Steel Products (Holdings) Ltd v British Steel Corporation [1986] Ch 246 at 276-278 (Slade LJ) and 302 (Browne-Wilkinson LJ). Ratio |
But in this appeal there is no difference between the parties as to the narrower and wider meanings of ultra vires in the company law context. Ratio |
Whether a transaction infringes the common law rule is a matter of substance, not form. Ratio |
The label attached to the transaction by the parties is not decisive. Ratio |
That is a theme running through the authorities, including Ridge Securities Ltd v Inland Revenue Commissions [1964] 1 WLR 479 and Aveling Barford Ltd v Perion Ltd [1989] BCLC 626 to which I have already referred. Ratio |
I shall take some of the best-known cases in chronological order. Ratio |
Ridge Securities was concerned with a complicated and artificial tax- avoidance scheme carried out at a time when companies were still subject to income tax (rather than corporation tax). PRE |
Pennycuick J (at p493), upheld the Special Commissioners disallowance of payments of interest grotesquely out of proportion to the principal amounts secured as not being interest within the meaning of section 169 of the Income Tax Act 1952. PRE |
That was simply a point of construction on the taxing statute. PRE |
More radically, Pennycuick J also dealt with a company law point not raised before the Special Commissioners, and held that the payments of so-called interest were in fact gratuitous (and so unlawful) dispositions of the companys money. PRE |
In the crucial passage ([1964] 1 WLR 479, 495, set out at para 1 above) the words however described are important. PRE |
Re Halt Garage (1964) Ltd [1982] 3 All ER 1016 was, on its facts, at the other extreme from Ridge Securities as regards the sophistication of the parties involved and the outlandishness of the impugned transaction. PRE |
The company owned what was essentially a husband-and-wife business running a garage near Woburn Sands. PRE |
From 1964 the couple worked very hard to build up the business, which included recovering broken-down vehicles from the newly-opened M1. PRE |
They paid themselves modest remuneration as directors. PRE |
But unfortunately in 1967 the wife became seriously ill and they decided to move to the Isle of Wight. PRE |
They tried to sell the business but repeatedly failed to do so, and at one stage the husband was commuting between the Isle of Wight and Bedfordshire in an attempt to look after his invalid wife and the ailing business. PRE |
Other misfortunes followed and the company went into insolvent liquidation in 1971. PRE |
The liquidator challenged the propriety of directors remuneration paid to the husband and wife during the companys decline. PRE |
Oliver J upheld the husbands remuneration but reluctantly disallowed most of the wifes last two years remuneration. PRE |
He observed (at 1043) The real question is, were these payments genuinely directors remuneration? If your intention is to make a gift out of the capital of the company, you do not alter the nature of that by giving it another label and calling it remuneration. PRE |
That was, with respect, hardly apt on the facts of the case. PRE |
The evidence suggested that the couple knew little about company law and took the advice of their accountant. PRE |
But the case does show that if the label of remuneration does not square with the facts, the facts will prevail and the result may be an unlawful distribution, even if the directors in question intended no impropriety. PRE |
Later in his judgment Oliver J recognized that, observing (at 1044): In the absence of any evidence of actual motive, the court must, I think, look at the matter objectively and apply the standard of reasonableness. PRE |
In Aveling Barford Ltd v Perion Ltd [1989] BCLC 626 a Singapore businessman, Dr Lee, who indirectly owned and controlled Aveling Barford, procured the sale by it to Perion (a Jersey company also controlled by Dr Lee) of a country house and 18 acres of land at Grantham, formerly used as an employees social and sports cl... |
This property had development potential and had been valued by Strutt and Parker at 650,000 and by Humberts (for prospective mortgagees) at 1,150,000. PRE |
The price on the sale to Perion was 350,000 (with a provision of doubtful authenticity for 400,000 overage if the property sold for over 800,000 within a year). PRE |
In the event it was sold within a year for over 1.5m. PRE |
That was the context in which Hoffmann J made the observations set out in para 1 above. PRE |
The need to look at substance rather than form also extended to Dr Lees being treated as the real shareholder in Aveling Barford and the real purchaser of the land: Hoffmann J made a passing reference to this at p632 but it was not an issue in the case. PRE |
Hoffmann J referred to Ridge Securities and Halt Garage and concluded (at 633) with an instructive passage referring to Rolled Steel: It is clear however that Slade LJ excepted from his general principle cases which he described as involving a fraud on creditors (see . . . PRE |
[1986] Ch246 at 296). PRE |
As an example of such a case, he cited Re Halt Garage. PRE |
Counsel for the defendants said that frauds on creditors meant transactions entered into when the company was insolvent. PRE |
In this case Aveling Barford was not at the relevant time insolvent. PRE |
But I do not think that the phrase was intended to have such a narrow meaning. PRE |
The rule that capital may not be returned to shareholders is a rule for the protection of creditors and the evasion of that rule falls within what I think Slade LJ had in mind when he spoke of a fraud on creditors. PRE |
There is certainly nothing in his judgment to suggest that he disapproved of the actual decisions in Re Halt Garage or Ridge Securities. PRE |
As for the transaction not being a sham, I accept that it was in law a sale. PRE |
The false dressing it wore was that of a sale at arms length or at market value. PRE |
It was the fact that it was known and intended to be a sale at an undervalue which made it an unlawful distribution. PRE |
Hoffmann Js acceptance that the sale was not a sham, but was a transaction in a false dressing, has an obvious parallel in developments which were taking place at the same time in landlord and tenant law. PRE |
In Street v Mountford [1985] AC 809 Lord Templeman famously struck down an artificial arrangement designed to avoid a tenancy protected by the Rent Acts. PRE |
He declared (at 825) that the court should be astute to detect and frustrate sham devices and artificial transactions whose only object is to disguise the grant of a tenancy and to evade the Rent Acts. PRE |
But three years later in Antoniades v Villiers [1990] 1 AC 417, 462 Lord Templeman said that it would have been more accurate to have used the word pretence, and the rest of the Appellate Committee took the same line (Lord Bridge at 454 an attempt to disguise the true character of the agreement; Lord Ackner at 466 the ... |
he sought vigorously to disguise them; Lord Oliver at 467 an air of total unreality about these documents ; Lord Jauncey at 477 mere dressing up in an endeavour to clothe the agreement with a legal character which it would not otherwise have possessed). PRE |
Antoniades v Villiers was decided before Aveling Barford and Hoffmann J may well have had it in mind when writing his judgment. PRE |
There is however one obvious difference between the typical case of a disguised company distribution and the typical case of a tenancy disguised as a licence in order to avoid the Rent Acts. PRE |
There is no identity of interest between the landlord and the putative licensee quite the reverse and the latter agrees to enter an artificial arrangement, against his or her interest, because of the weak bargaining position of anyone looking for affordable accommodation in an overcrowded city. PRE |
In the disguised company distribution case, by contrast, the same human beings are usually interested directly or indirectly, on both sides of the corporate manoeuvring: Dr Lee in Aveling Barford, anonymous financiers in Ridge Securities. PRE |
The fact that the same individuals are interested on both sides is not of course, by itself, a cause for alarm, since company reconstructions are carried out for all sorts of entirely proper purposes (and now have the benefit of sections 845 and 846 of the Companies Act 2006). PRE |
The point to which I draw attention is simply that where there is a degree of identity of interest between both sides to a corporate transaction, both sides are likely to be in agreement as to its real purpose and its true nature and substance. PRE |
A question of characterisation Ratio |
The essential issue then, is how the sale by PPC of its shareholding in YMS is to be characterised. Ratio |
That is how it was put by Sir Owen Dixon CJ in Davis Investments Pty Ltd v Commissioner of Stamp Duties (New South Wales) (1957) 100 CLR 392, 406 (a case about a company reorganisation effected at book value in which the High Court of Australia were divided on what was ultimately an issue of construction on a stamp dut... |
The same expression was used by Buxton LJ in MacPherson v European Strategic Bureau Ltd [2000] 2 BCLC 683, para 59. Ratio |
The deputy judge did not ask himself (or answer) that precise question. Ratio |
But he did (at paras 39-41) roundly reject the submission made on behalf of PPC that there is an unlawful return of capital whenever the company has entered into a transaction with a shareholder which results in a transfer of value not covered by distributable profits, and regardless of the purpose of the transaction. ... |
A relentlessly objective rule of that sort would be oppressive and unworkable. Ratio |
It would tend to cast doubt on any transaction between a company and a shareholder, even if negotiated at arms length and in perfect good faith, whenever the company proved, with hindsight, to have got significantly the worse of the transaction. Ratio |
In the Court of Appeal Mummery LJ developed the deputy judges line of thought into a more rounded conclusion (para 30): In this case the deputy judge noted that it had been accepted by PPC that the sale was entered into in the belief on the part of the director, Mr Moore, that the agreed price was at market value. Rati... |
In those circumstances there was no knowledge or intention that the shares should be disposed of at an undervalue. Ratio |
There was no reason to doubt the genuineness of the transaction as a commercial sale of the YMS1 shares. Ratio |
This was so, even though it appeared that the sale price was calculated on the basis of the value of the properties that was misunderstood by all concerned. Ratio |
In seeking to undermine that conclusion Mr Collings QC (for PPC) argued strenuously that an objective approach is called for. Ratio |
The same general line is taken in a recent article by Dr Eva Micheler commenting on the Court of Appeals decision, Disguised Returns of Capital An Arms Length Approach, [2010] CLJ 151. Ratio |
This interesting article refers to a number of cases not cited to this court or to the courts below, and argues for what the author calls an arms length approach. Ratio |
If there were a stark choice between a subjective and an objective approach, the least unsatisfactory choice would be to opt for the latter. Ratio |
But in cases of this sort the courts real task is to inquire into the true purpose and substance of the impugned transaction. Ratio |
That calls for an investigation of all the relevant facts, which sometimes include the state of mind of the human beings who are orchestrating the corporate activity. Ratio |
Sometimes their states of mind are totally irrelevant. Ratio |
A distribution described as a dividend but actually paid out of capital is unlawful, however technical the error and however well-meaning the directors who paid it. Ratio |
The same is true of a payment which is on analysis the equivalent of a dividend, such as the unusual cases (mentioned by Dr Micheler) of In re Walters Deed of Guarantee [1933] Ch 321 (claim by guarantor of preference dividends) and Barclays Bank plc v British & Commonwealth Holdings plc [1996] 1 BCLC 1 (claim for damag... |
Where there is a challenge to the propriety of a directors remuneration the test is objective (Halt Garage), but probably subject in practice to what has been called, in a recent Scottish case, a margin of appreciation: Clydebank Football Club Ltd v Steedman 2002 SLT 109, para 76 (discussed further below). Ratio |
If a controlling shareholder simply treats a company as his own property, as the domineering master-builder did in In re George Newman & Co Ltd [1895] 1 Ch 674, his state of mind (and that of his fellow-directors) is irrelevant. Ratio |
It does not matter whether they were consciously in breach of duty, or just woefully ignorant of their duties. Ratio |
What they do is enough by itself to establish the unlawful character of the transaction. Ratio |
The participants subjective intentions are however sometimes relevant, and a distribution disguised as an arms length commercial transaction is the paradigm example. Ratio |
If a company sells to a shareholder at a low value assets which are difficult to value precisely, but which are potentially very valuable, the transaction may call for close scrutiny, and the companys financial position, and the actual motives and intentions of the directors, will be highly relevant. Ratio |
There may be questions to be asked as to whether the company was under financial pressure compelling it to sell at an inopportune time, as to what advice was taken, how the market was tested, and how the terms of the deal were negotiated. Ratio |
If the conclusion is that it was a genuine arms length transaction then it will stand, even if it may, with hindsight, appear to have been a bad bargain. Ratio |
If it was an improper attempt to extract value by the pretence of an arms length sale, it will be held unlawful. Ratio |
But either conclusion will depend on a realistic assessment of all the relevant facts, not simply a retrospective valuation exercise in isolation from all other inquiries. Ratio |
Pretence is often a badge of a bad conscience. Ratio |
Any attempt to dress up a transaction as something different from what it is is likely to provoke suspicion. Ratio |
In Aveling Barford there were suspicious factors, such as Dr Lees surprising evidence that he was ignorant of the Humberts valuation, and the dubious authenticity of the overage document. Ratio |
But in the end the disparity between the valuations and the sale price of the land was sufficient, by itself, to satisfy Hoffmann J that the transaction could not stand. Ratio |
The right approach is in my opinion well illustrated by the careful judgment of Lord Hamilton in Clydebank Football Club Ltd v Steedman 2002 SLT 109. Ratio |
It is an example of the problems which can arise with football clubs owned by limited companies, where some small shareholders see the club as essentially a community enterprise, and other more commercially-minded shareholders are concerned with what they see as underused premises ripe for profitable redevelopment. Rat... |
The facts are complicated, and the main issue was on section 320 of the Companies Act 1985 (approval by company in general meeting of acquisition of non-cash asset by director or connected person). Ratio |
But the judge also dealt with a claim under section 263 (unlawful distribution). Ratio |
He held that the sale of the clubs derelict ground at Kilbowie Park, and another site originally purchased under an abortive plan for a new ground, was a genuine arms-length sale even though effected at a price 165,000 less than the value as eventually determined by the court after hearing expert evidence. Ratio |
In para 76 Lord Hamilton said: It is also clear, in my view, that a mere arithmetical difference between the consideration given for the asset or assets and the figure or figures at which it or they are in subsequent proceedings valued retrospectively will not of itself mean that there has been a distribution. PRE |
If the transaction is genuinely conceived of and effected as an exchange for value and the difference ultimately found does not reflect a payment manifestly beyond any possible justifiable reward for that in respect of which allegedly it is paid, does not give rise to an exchange at a gross undervalue and is not otherw... |
In assessing the adequacy of the consideration, a margin of appreciation may properly be allowed. PRE |
The words quoted by Lord Hamilton are from Halt Garage and Aveling Barford. PRE |
In para 79 Lord Hamilton said: It is plain, in my view, that directors are liable only if it is established that in effecting the unlawful distribution they were in breach of their fiduciary duties (or possibly of contractual obligations, though that does not arise in the present case). Ratio |
Whether or not they were so in breach will involve consideration not only of whether or not the directors knew at the time that what they were doing was unlawful but also of their state of knowledge at that time of the material facts. Ratio |
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