Lifecycle of a Business – Endeavours clauses

• 18 June 2024
• News

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

We’ve already discussed various topics, such as, set up, directors, funding, employment and shareholder-related matters, but now let’s concentrate on Commercial Contracts.

Endeavours clauses

An endeavours clause is a provision in a contract that requires a party to use a certain level of effort to try and achieve a specified result. These clauses are commonly used when a party is willing to attempt to fulfil an obligation without committing to do so absolutely. There are several “levels” of endeavours clauses, each of which require different amounts of effort, such that it can be unclear as to how far a party must go to try and meet the obligation.

Failure to fulfil an enforceable endeavours clause constitutes a breach of contract, which can have various repercussions, including your being liable to pay damages to the other party and termination. As such, it is crucial that you have a clear understanding of the scope of any endeavours clause before agreeing to it.

Levels of endeavours clauses

There are three “standard” endeavours clauses (“best endeavours”, “reasonable endeavours” and “all reasonable endeavours”). For two of these, case law has resulted in a fairly clear understanding of what will be required from the endeavouring party (the obligor). Accordingly, the extent of a party’s obligations will depend on the agreed wording of the clause.

Best endeavours

A best endeavours clause (for example, “The Company shall use best endeavours to deliver the Goods to the Buyer within the timescales set out in clause 9”) imposes the most onerous standard on the obligor.

Whilst not an absolute obligation, the starting point is that a best endeavours clause “means what the words say; they do not mean second-best endeavours” (Sheffield District Railway Co v Great Central Railway Co).

Essentially, the obligor must put itself in the shoes of the person to whom the obligation is owed (the obligee). Therefore, by agreeing to a best endeavours clause you commit to doing everything possible to achieve the desired result, even if it means sacrificing your own commercial interests and incurring significant costs. For example, in a case between Jet2.com and Blackpool Airport, the Court of Appeal held that the airport was obliged to open outside of its usual operating hours to accommodate Jet2’s flight times. By agreeing to use best endeavours to promote the budget airline’s flights, the airport had inadvertently agreed to open during night-time hours, regardless of the inconvenience and financial cost involved.

If you are the obligor, we recommend that you take legal advice before agreeing to use “best endeavours” but, at the very least, you should think extremely carefully about the steps that such a clause will require you to take (and the cost and practicalities of these).

Reasonable endeavours

“Reasonable endeavours” (for example, “The Purchaser shall use reasonable endeavours to obtain the necessary approvals, consents and licences by 20 April 2024”) is the least burdensome of the three standard clauses, but even so, it should not be agreed to lightly.

Case law has determined that the standard imposed by a requirement to use “reasonable endeavours” is a question of “what would a reasonable and prudent person acting properly in their own commercial interest… have done to try” to achieve the objective (Minerva (Wandsworth) Ltd v Greenland Ram (London) Ltd). This implies an objective approach based on the reasonable obligor, not the obligee as is the case for “best endeavours”.

The courts have considered the obligations behind a “reasonable endeavours” clause in minute detail. Crucially, the obligor is not typically required to sacrifice its own commercial interests and may be entitled to consider the impact on its profitability. In addition, the likelihood of achieving the desired result should be considered and once the obligor has taken all reasonable steps to achieve the objective, it is not required to continue trying.

Although less demanding than a “best endeavours” clause, this obligation is still significant and will form an enforceable commitment that may be challenging to meet. In particular, any attempt to manipulate circumstances to avoid fulfilling the obligation will likely constitute a breach.

All reasonable endeavours

The third commonly used endeavours clause is “all reasonable endeavours” (for example, “The Contractor shall use all reasonable endeavours to complete the Project by the Long Stop Date”). Whilst such clauses are commonly seen as a compromise between best and reasonable endeavours, this is not necessarily the case, and their meaning is controversial.

The courts have indicated, without deciding the point, that it is “probably a middle position somewhere between” reasonable endeavours and best endeavours. However, it has also been suggested that in meeting an all reasonable endeavours obligation, an obligor would be required to take all reasonable courses of action, thereby sacrificing its own commercial interests to comply with the obligation.

The current stance is that a court will interpret it based on the context of the contract and the parties involved. This obviously results in uncertainty as to what an obligor will actually be required to do in practice to comply with such a clause. As such, obligors should be cautious when agreeing to an all reasonable endeavours clause; it would be prudent to consider such a clause to be equally as burdensome as a best endeavours clause and to take legal advice before agreeing to such wording.

Alternative options

Over time, variations of the three most commonly used endeavours clauses have come into being. You may see phrases such as “commercially reasonable endeavours” and “all reasonable but commercially prudent endeavours”, which are used to try and soften a reasonable endeavours obligation. However, case law on these terms is inconclusive, making it unclear how the courts might differentiate between them. Consequently, including such clauses in a contract is risky and may result in uncertainty regarding the parties’ obligations. As such, it is advisable to avoid using these variations.

It is also relatively common to see terms such as “best efforts” instead of “best endeavours” and “all reasonable steps” instead of “all reasonable endeavours”. Although the courts are likely to treat these as interchangeable phrases, we suggest sticking to the tried and tested “endeavours” wording.

Practical takeaways

• Ideally, any endeavours clause should clearly outline the steps a party must take to fulfil its obligations. For example, if one party needs to spend money to achieve the result, the contract should specify this and include the maximum amount to be spent. Similarly, if a party is required to speak to certain people within a set timeframe, the contract should list who these people are, what needs to be discussed and include a deadline for the discussions
• Draft any endeavours clauses very carefully and seek legal advice if you are unsure about the requirements and the extent of your obligations. Failing to meet an endeavours clause may result in your being in breach of contract
• Limit yourself to “reasonable endeavours” or “best endeavours”. Avoid using vague or diluted language as it can create uncertainty and, if the matter goes to court, you might discover that your obligations are more burdensome than you had anticipated
• If you are the obligor, maintain an accurate record of the steps taken towards satisfying your obligations. Such evidence could be extremely helpful to you if a dispute arises

Disclaimer

This note reflects the law as at 14 June 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

Lifecycle of a Business – How can a company reduce its share capital?

• 29 February 2024
• News

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

So far, we’ve covered initial considerations, directors and funding, so now let’s have a think about “Shareholders”.

How can a company reduce its share capital?

Every company limited by shares has a share capital. This is the amount of money paid to the company by its shareholders when they subscribe for their shares and consists of the nominal value of the share plus any share premium. It might total pennies or hundreds of millions of pounds.

In theory, because the shareholders of a company have the protection of limited liability and so cannot be liable for the company’s debts, a company’s share capital is the fund of last resort for its creditors. The company may make distributions of its realised profits to shareholders, but they cannot get their capital back. However, companies have many reasons for wanting to reduce their share capital. These might include:

1. having too much share capital;
2. having lost capital, so the share capital no longer represents the company’s assets;
3. cancelling liabilities on partly paid shares;
4. creating distributable reserves; or
5. simplifying corporate structures.

For example, a company might have a substantial share premium account. It might also have significant cash, but also accumulated losses that prevent it from paying a dividend. If the share premium account is reduced, it could increase its reserves, so enabling a dividend to be paid, while not affecting the number of shares in issue.

Company law therefore allows reductions of capital subject to strict limitations. A company can reduce its share capital by a special resolution confirmed by the court (as has long been the case), but the Companies Act 2006 gave private companies access to a quicker and easier method, where the special resolution is supported by a solvency statement by the directors and the court is not involved.

A reduction of capital supported by a solvency statement is conducted as follows:

1. The directors meet to approve the reduction and sign the solvency statement. All the directors must sign the solvency statement to confirm that:
   1. they have taken into account the company’s liabilities; and
   2. there is no grounds on which the company could be found to be unable to pay its debts and that it will continue to be able to do so for the next 12 months (or, if the company is to be wound up, that it will continue to be able to do so within 12 months of the commencement of the winding up).
2. The shareholders approve any amendment required to the company’s articles of association (for example, because they prohibit a reduction of capital) and the reduction of capital, each by special resolution, either at a general meeting or by written resolution. The solvency statement must be signed by the directors not more than 15 days before the resolution is passed and be made available at the general meeting or circulated with the written resolution.
3. The directors all sign a statement of compliance confirming that:
   1. the solvency statement was provided to all the shareholders; and
   2. the resolution was passed within 15 days of the solvency statement being made.
4. Within 15 days of the special resolution being passed, the signed solvency statement, a copy of the special resolution(s), the compliance statement, Companies House form SH19 and a copy of any amended articles of association are delivered to Companies House with the necessary fee (currently £10 or £50 for same day processing, although Companies House fees are to increase from 1 May 2024 with the revised fee for registering a reduction of capital being £33 or £136 for same day processing). The reduction of capital takes effect only when the registrar has accepted and registered the filing.

Once registered, the company can then take the steps approved by the resolution, usually either by repaying the shareholders directly or crediting the amount reduced to a reserve, and making any necessary changes in its registers. The company is permitted to reduce its share capital “in any way” as long as there is at least one non-redeemable share remaining, so it has a great deal of scope to reorganise its capital under this section.

The above assumes that all shareholders are being treated in the same way. If it is intended to treat shareholders differently (perhaps to pay one shareholder out or to return capital relating to a certain class of shares) it may be necessary to consider obtaining class consents and take into account the risk of a shareholder bringing a claim for unfair prejudice.

Reductions of capital: a tax perspective

Repayment of share capital

When capital is returned to an individual shareholder without first passing through the company reserves, the repayment of capital (i.e. the amount paid for the shares, which will be the sum of the nominal value and the share premium (if any)), is treated by HMRC as a capital distribution and so within the capital gains tax (CGT) / corporation tax on chargeable gains rules. There is a part disposal of the underlying shares (some small part disposals may be ignored at the time of the repayment and, instead, the consideration in question is deducted from the allowable deductions on the subsequent disposal of the shares). Where the repayment is not “small” then it may be possible to claim Business Asset Disposal Relief (BADR) but HMRC are alive to possible abuse and may recharacterise as income under the transactions in securities (TIS) rules (and it is often prudent to seek a clearance from HMRC before undertaking the transaction where the reduction of capital is in respect of a “close” company).

If the payment goes beyond the amount paid for the shares there is an income distribution.

Distribution from reserves

If a company decides to transfer the funds from the capital reduction to its reserves, generally this is treated as a realised profit. The company can then decide to make a dividend payment to its shareholders from that profit or leave it in its reserves.

If it decides to pay a dividend to its shareholders then an individual recipient will be subject to income tax, but a corporate shareholder will generally be able to rely on an exemption from corporation tax.

Conclusion

Undertaking a capital reduction within your company can be a complex process and the best method of doing so will vary greatly depending on the circumstances of your company and your shareholders. Please contact the Forsters’ Corporate team if you would like tailored advice for your company.

Disclaimer

This note reflects the law as at 29 February 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

Lifecycle of a Business – General meetings – a step by step guide

• 23 February 2024
• News

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

So far, we’ve covered initial considerations, directors and funding, so now let’s have a think about “Shareholders”.

General meetings – a step by step guide

While the board of directors of a company is responsible for the day-to-day, operating decisions of the company, there are various issues which, under the Companies Act 2006 (the Act), require shareholder approval. (A company’s articles of association (the articles) and any shareholders’ agreement which is in place may also set out matters which require shareholder consent.) For private limited companies incorporated in England and Wales, such approval is usually obtained by the passing of shareholder resolutions, either in an actual meeting of the shareholders or by written resolution.

Shareholder meetings

Meetings of shareholders are referred to as general meetings and any number of general meetings can be held throughout the year. Private companies may also hold an annual general meeting (AGM) once a year, at which, for example, directors may be elected, dividends declared and the annual accounts approved. Private companies are not required to hold an AGM under the Act, although their articles may provide otherwise.

Until recently, general meetings were usually held in-person but as technology has improved and become more widespread, there’s now the option to hold virtual or hybrid general meetings as well. There are pros and cons to such meetings, which pose additional factors to consider and as such, they fall outside the scope of this article.

Step 1: Calling the general meeting

General meetings are usually called by the board of directors and the calling of the general meeting, together with the form of the notice of the general meeting, should be approved by the directors.

Shareholders representing at least 5% of the paid-up voting shares in the company may also request the directors to call a general meeting. (The process for calling such a general meeting is a little different and is outside the scope of this article.)

Notice of the general meeting must be sent to all shareholders who are entitled to receive notice (plus the directors and company’s auditors (if any)) and the notice must include certain information. As a minimum, the notice must set out the date, time and location of the general meeting and the general nature of the business to be conducted. If any special resolutions are to be tabled at the meeting, the wording of the special resolutions must be included in the notice. Other, administrative information must also be provided, such as how a member can appoint a proxy to attend the meeting and vote on their behalf. In addition, the articles and any shareholders’ agreement must be reviewed to ensure that any provisions dealing with notice entitlement are complied with; this may be particularly relevant where, for example, there are different classes of shares in issue. Failure to send due notice will result in the meeting not having been validly convened.

It’s also important to consider what supporting information (if any) is required to be provided to the shareholders ahead of the meeting. For example, when an AGM is being called, a copy of the company’s annual report and accounts will need to be provided; these usually accompany the AGM notice.

Notice of the general meeting can be sent in hard copy form or, subject to certain requirements, in electronic form. Notice may also be placed on a website (again, subject to certain requirements).

Step 2: Ensure that the correct notice period is given

Under the Act, the length of notice required to be given for a general meeting called by the directors is generally a minimum of 14 clear days, although the articles may set out a longer period. (A longer period is also required where certain resolutions are being proposed.) Reference to “clear days” means that the day that the notice is given and the day of the meeting are not to be taken into account. When calculating the notice period, don’t forget about delivery. Under the Act, delivery by post or e-mail is deemed to occur 48 hours after posting or sending (non-working days shouldn’t be taken into account), although the articles may provide for a shorter deemed delivery period. So, for example, assuming that the articles are silent about deemed delivery, if notice is sent on Monday 25th March 2024, the earliest date that the general meeting can be held will be 11th April 2024.

A shorter notice period may be given if a majority in number of shareholders who, together hold at least 90% of the nominal value of the voting shares, agree. This percentage can be increased in the articles to a maximum of 95%.

Step 3: Is the meeting quorate?

The day of the meeting has arrived but in order to be valid, the meeting must be quorate. Generally, there must be two people present (and those people must represent different shareholders) for quorum to be achieved, unless the company only has one shareholder or the articles provide otherwise.

If the meeting isn’t quorate, the chair may choose to adjourn the meeting. Adjournment provisions are usually included in the articles.

Step 4: Running the general meeting

A chair will need to be appointed to facilitate and lead the meeting. This will usually be the chair of the board or another director, but a shareholder or a proxy can also take on this role. Depending on the size of the company and the nature of the business of the meeting, it may be advisable for the chair to use a pre-prepared script.

Shareholders, proxies and, usually, directors, as well as certain other persons, are able to speak at a general meeting and it’s advisable for the chair to let them do so. The chair can, however, take certain steps to stop obstructive behaviour, including adjourning the meeting and even removing the person(s) in question from the meeting, although removal should only be used as a last resort.

Step 4: Passing the resolutions

How the proposed resolutions are passed will depend on how the vote is taken and the type of resolution.

Votes can be taken on a simple show of hands (where each shareholder has one vote) or on a poll (where each shareholder has one vote for every ordinary share held). Votes will be taken on a show of hands unless a poll is specifically requested.

An ordinary resolution will be passed:

• on a show of hands if it’s passed by a simple majority of the votes cast by the shareholders entitled to vote; or
• on a poll if it’s passed by shareholders representing a simple majority of the total votes of the shareholders who vote on the resolution.

A special resolution will be passed:

• on a show of hands if it’s passed by a majority of not less than 75% of the votes cast by the shareholders entitled to vote; or
• on a poll if it’s passed by shareholders representing at least 75% of the total voting rights of the shareholders who vote on the resolution.

Step 5: Post-meeting matters

The end of the meeting doesn’t necessarily mean that the process is complete. Various formalities will need to be dealt with, for example, writing up the minutes of the meeting, making any requisite filings at Companies House and updating any registers of the company.

Written resolutions

Instead of holding a general meeting, the shareholders of private companies can also pass written resolutions for the majority of actions which require their approval. This is helpful for companies who have only a small number of shareholders and can be a much quicker way of obtaining shareholder approval. The procedure is set out in the Act and failure to follow this correctly can constitute a criminal offence.

The procedural specifics will depend on whether the directors or shareholders propose the written resolution but broadly, a written resolution must:

• be sent to all shareholders entitled to vote on the date that the resolution is circulated (the circulation date);
• state whether any proposed resolutions are special resolutions;
• include directions as to how to approve the resolution; and
• set out the deadline for when the resolution must be passed (28 days after the circulation date unless the articles say otherwise). If the resolution isn’t passed by the deadline date, it will lapse.

A copy must also be sent to the company’s auditors (if any).

If the shareholder agrees to the resolution, they must signify as such on the document and return it to the company. A written ordinary resolution will pass if shareholders representing over 50% of the total voting rights of the shareholders entitled to vote approve it. A written special resolution will pass if shareholders representing at least 75% of the total voting rights of the shareholders entitled to vote approve it.

Practical points

The steps to be taken to call and hold a general meeting are fairly formulaic, especially for companies with a smaller shareholder base. However, don’t forget to consider whether a written resolution may be a more practical option.

Thinking ahead, where possible, is advisable. Preparing the documentation required well in advance and being clear on the resolutions to be proposed and the voting process, will minimise the risk of errors and omissions.

Whether you choose to call a general meeting or circulate a written resolution, it’s important that the statutory procedure is followed correctly and that the articles and any shareholders’ agreement are checked to ensure that they are complied with. Getting this wrong could invalidate the meeting or even be a criminal offence. Your legal advisors will be able to assist if you’re unsure.

Lifecycle of a Business – Dividends

• 15 February 2024
• News

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

So far, we’ve covered initial considerations, directors and funding, so now let’s have a think about “Shareholders”.

Dividends

Our recent articles have referred to the payment of dividends to shareholders . In this article, we delve into how profits and retained earnings of a private company can be distributed among its shareholders by way of dividend. We discuss when and how much may be distributed and also look at restrictions that might apply to private companies (the additional restrictions placed on public companies with respect to dividends are out of scope of this particular article).

What are dividends?

Dividends are a type of distribution made by a company to its shareholders and are a way of returning some of the profits of a company directly to its shareholders. They’re generally paid in cash, but might also be non-monetary payments such as shares in the company (scrip dividends) or physical assets (dividends in specie).

Where a company declares a dividend, and that company has only one class of share in issue, it must declare and pay dividends equally on each share. Companies with more than one class of share in issue may wish to allocate different dividend rights to each class.

When can dividends be paid?

A company may only distribute dividends out of the profits available to it for any such distribution, that is, the company’s accumulated, realised profits, less its accumulated, realised losses, as they are stated in the company’s annual, interim, or initial accounts (as the case requires). In other words, the company must have sufficient distributable profits to pay the dividend.

As to timing, a dividend can be paid at any point in time but will generally be paid:

• as a final dividend once the company’s end of year financial statements have been prepared. This usually requires shareholder approval, often at the company’s annual general meeting; or
• as an interim dividend at any time during the financial year before the company determines its annual profits. This does not usually require shareholder approval.

Special or “one-off” dividends can also be paid as and when appropriate.

Amount of any dividend

Provided there are sufficient distributable profits available to the company to cover any payment of any declared dividend, and its constitutional documents allow it, there is no restriction as to the amount of dividend that may be declared and distributed to a company’s shareholders.

Declaring a dividend

The manner in which a company may declare a dividend (if at all) will usually be set out in its articles of association or in a shareholders’ agreement in relation to that company and these should always be checked before declaring any dividend.

There is no legal obligation on the company or its directors to declare a dividend. As such, a company may decide to use its profits for other purposes, for example, as working capital, to invest, to pay dividends at a later date (retained earnings), to cover any unexpected circumstances that might arise, to reinvest in its business for growth and expansion, or to pay down debt.

Final dividends

A final dividend usually requires the approval by ordinary resolution of the company’s shareholders (where the directors have resolved to recommend the amount of any such dividend). This approval is usually obtained at the company’s annual general meeting at which the annual accounts are also approved.

Once a final dividend has been declared by its shareholders, it becomes a debt due and payable by the company on the date of the resolution, unless some future date for payment is specified.

Interim dividends

Provided that the company’s articles of association or any shareholders’ agreement allows, the directors may decide to pay interim dividends at any time, provided that the company has sufficient distributable profits. (It should be noted that the model articles of association permit the payment of interim dividends by default.) The company’s annual and interim accounts will likely be produced at the board meeting at which the interim dividend is to be approved.

An interim dividend may be varied or rescinded at any time after it is declared and before payment is actually made and may, therefore, only be regarded as due and payable when it is actually paid.

Tax implications

The payment of a dividend by a UK company is not deductible when the company’s taxable profits are computed.

Generally, there is no withholding tax when a UK company pays a dividend (although there are exceptions for some types of investment funds).

When a company may not pay a dividend

A company’s articles of association or any shareholders’ agreement in force in relation to a company might place certain restrictions on the directors’ and/or shareholders’ ability to make dividends.

In addition, dividends which contravene certain sections of the Companies Act 2006 (the Act) (for example, one declared where a company does not have sufficient distributable profits) or common law (for example, a distribution out of capital) are classed as unlawful dividends and should not be paid.

Consequences of making an unlawful dividend

Where the directors declare and distribute a dividend in circumstances where there are insufficient profits available to distribute, they will likely be in breach of their statutory duties contained in the Act, such as their duty to promote the success of the company for the benefit of its shareholders as a whole, or their common law duty to consider the interests of the company’s creditors (rather than the shareholders) in circumstances where the company is facing insolvency (our article, “A Balancing Act – when do directors owe a duty to creditors?“, considers the circumstances when a director owes a duty to creditors following the Supreme Court judgment in BTI v Sequana). This could have various adverse consequences, including disqualification as a director.

No criminal penalties attach to the payment of unlawful dividends, but a director could be held personally liable to repay the company. For further information about this, please see here.

Paying a dividend when the company is insolvent or subsequently becomes insolvent could also have consequences under insolvency law.

Takeaways

Paying dividends can send a positive message about a company’s current financial strength and future prospects. Many investors like the income associated with dividends and so may be more likely to invest in a company that pays regular dividends.

On the other hand, a company that is still growing should carefully consider whether paying a dividend is advisable; it may be preferable to instead reinvest any profits into its future growth, pay off some debt or use the profits for working capital purposes, for example. And, as discussed above, a company that doesn’t have sufficient profits shouldn’t declare a dividend in the first place; doing so could result in the directors being held personally liable to repay the company.

The decision whether to pay a dividend or not may not be clear-cut. Directors must consider their statutory duties, as well as the financial situation of the company, its constitutional documents, and any tax implications. Speaking to your legal advisor or accountant (or both) is advisable in this situation.

Disclaimer

This note reflects the law as at 14 February 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

Lifecycle of a Business – Protections for Minority Shareholders

• 7 February 2024
• News

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

So far, we’ve covered initial considerations, directors and funding, so now let’s have a think about “Shareholders”.

Protections for Minority Shareholders

Minority shareholders are those who cannot, by themselves, control the direction a company will take and, as a result, may be adversely affected by decisions made by the majority shareholder(s). This article sets out some of the rights a minority shareholder may seek in a private limited company in England and Wales and those provisions that majority shareholders can expect their minority shareholders to raise.

Legislation

Legislation offers certain limited protections for minority shareholders, some of which were mentioned in our last article, ‘What are your rights as a shareholder?’. In addition to the points mentioned in that article:

1. a shareholder can block special resolutions where they, either by themselves or with other shareholders, hold more than 25% of the voting shares in the company. This can stop key matters passing, such as changing the company’s articles of association;
2. a shareholder can cause a general meeting of the shareholders to be called where they, either by themselves or with other shareholders, hold at least 5% of the paid-up shares that have the right to vote. Alternatively, those shareholders with 5% of the voting rights can arrange for a written resolution to be circulated. Either action will enable the shareholder(s) to put matters in front of the other shareholders for them to vote on;
3. any shareholder can bring a claim for unfair prejudice against the company (where actions have been, or are being, taken that are, or would be, unfairly prejudicial to the shareholders, or some of them), although it should be noted that a common outcome of this process is that the court orders the majority shareholder to buy out the minority shareholder;
4. any shareholder can bring a derivative action against a director for actions such as negligence, default, breach of duty or a breach of trust. However, bear in mind that this is an action brought in the name of the company and so any damages recovered would not go to the shareholder; and
5. in certain qualifying cases, where a shareholder has held their shares for at least six of the preceding 18 months, they can apply to the court for the winding-up of the company, although it should be noted that the bar for success with this route is high.

Given the limited nature of the statutory protections on offer, minority shareholders often seek to negotiate contractual minority protections at the outset of their investment.

Contractual Protections

Contractual protections are usually found in the company’s articles of association and any shareholders’ agreement or investment agreement (which governs the relationship between the shareholders of a company) that is in place. They can include the following (subject to the specific requirements of the transaction and negotiations):

1. Reserved Matters: A majority shareholder may agree a list of matters which the company cannot carry out without the consent of the minority shareholder(s). These are usually the most important matters relating to the company which would affect a minority shareholder’s position, such as changes being made to the company’s articles of association, the taking out of a substantial loan by the company, the entry into significant contracts by it or the winding-up of the company.
2. Pre-Emption (Share Issue): Pre-emption rights on an issue of shares by the company enable a minority shareholder to avoid their shareholding being diluted by the future issue of new shares to third parties (or other shareholders), by giving the minority shareholder a right of first refusal to take up any of the new shares, usually in proportion to their shareholding at the time of issue. If a contractual protection is not included, and reliance is instead placed on the statutory pre-emption right, those holding 75% of the voting shares in the company can disapply the provision. That said, the purchase price for a minority stake can be substantial.
3. Pre-Emption (Share Transfer): Similarly, pre-emption rights can be included in respect of a transfer of shares, giving the minority shareholder a right to purchase certain of the shares of an outgoing shareholder, usually in proportion to the shares the minority shareholder already holds in the company. However, this can again be a costly process and the minority shareholder will need to ensure they have the funds to purchase the shares.
4. Board of Directors: A minority shareholder can, if its minority shareholding is appropriately significant (usually by reference to a percentage shareholding), request the right to appoint a director to the board and for that person to be present in order for any meeting to be quorate. If they are not able to obtain this right, they may be able to appoint an observer at board meetings so that they are aware of matters discussed by the board, albeit without having the voting rights that come with being a director.
5. Exit Right: Tag-along rights provide an exit route for minority shareholders where there will be a change of control of the company. Here, they are able to sell their shares to the same purchaser of the majority shareholder’s shares and on the same terms. This ensures that a consistent value is paid for the shares in the company and avoids the minority shareholder(s) being left in the business with a new party. Additionally, a minority shareholder may seek to include a put option, to ensure that if a dispute arises between the shareholders, for example, they will receive an agreed value for their shares or have a mechanism in place for an independent third party to confirm the value.
6. Information Rights: In addition to the statutory right to see certain company information, such as the company’s annual accounts and directors’ report, a minority shareholder may be able to obtain management reports throughout the year as a means of monitoring their investment in, and the performance of, the company.
7. Dividend Policy: Having a clear dividend policy in place will help to give certainty to a minority shareholder as to when they are likely to receive a dividend from the company in respect of their investment. Without this, minority shareholders are unable to pass or block an ordinary resolution to declare dividends.
8. Business Plan: In a joint venture scenario, a minority shareholder is likely to want to have a say in the signing-off of the annual business plan of the company, to ensure that the commercial objectives of the parties are clearly aligned.

Protections of this nature have been in the news recently with Sir Jim Ratcliffe’s investment into Manchester United. It is reported that he will have a right of first refusal for a year if the Glazer family sell their shares, but the Glazer family will be able to drag-along Sir Jim Ratcliffe if there is a full sale of the club after 18 months of the completion of his investment and provided that he receives at least $33 per share.

Conclusion

If you are a minority shareholder investing in a company, or a majority shareholder who has received a request for protections from an incoming investor, please do not hesitate to get in touch with a member of our Corporate team, who will be happy to assist you.

Disclaimer

This note reflects the law as at 2 February 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

Lifecycle of a Business – What are your rights as a shareholder?

• 23 January 2024
• News

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

So far, we’ve covered initial considerations, directors and funding, so now let’s have a think about “Shareholders”.

What are your rights as a shareholder?

A company acts through two bodies of people – its shareholders and its board of directors. While the directors manage the day-to-day running of the business, shareholders can still exert a significant amount of influence.

The rights of shareholders are derived from the Companies Act 2006 (the “Companies Act“), the articles of association of the company (the “Articles“) and any shareholders’ agreement in place. The rights attaching to shares will depend on the class (type) of shares that you hold and will vary from company to company. It is therefore important that you fully understand which class(es) of shares you own and the rights which apply to them.

In this article we will consider the key shareholder rights that are provided in the Companies Act.

Attendance and voting at general meetings

Generally, shareholders are entitled to attend and vote at general meetings of the company. However, some classes of shares may not have this right, while others may provide weighted voting rights or a veto right over certain issues; if this is the case, it should be set out in the Articles or any shareholders’ agreement.

Subject to any specific rights set out in the Articles or a shareholders’ agreement, a shareholder’s voting power will usually depend on the proportion of shares held (where the vote is by poll); however, in some instances a vote may be taken by show of hands and in this case, shareholders with a very small shareholding may have a significant impact on the vote. In the main, resolutions proposed at a general meeting will be either an ordinary resolution or a special resolution. An ordinary resolution is passed by simple majority (i.e. over 50%) while a special resolution must be passed by 75%.

In addition, subject to certain conditions being satisfied, shareholders have the right to require the directors to call a general meeting, the right to require the company to circulate a written resolution and the right to require the directors to circulate a statement with respect to a matter referred to in a proposed resolution or other business to be dealt with at a meeting.

If you are unable to attend a general meeting, you should be able to appoint a proxy to attend the meeting and vote on your behalf.

Right to dividends

Most shareholders will have the right to receive a share of the company’s profits in return for their investment. If a company is profitable, the directors may decide to distribute profits to shareholders by declaring the payment of a dividend (usually in cash).

Although it is the directors who will recommend the payment of a dividend, shareholders may have to vote to approve it (this is usually the case with a final dividend, which is paid once the annual accounts have been drawn up; interim dividends which are paid throughout the year are usually declared by the directors). The shareholders cannot vote to pay a final dividend which is more than the directors have recommended, although they can vote to reduce the amount of the dividend to be paid.

It should be remembered that the directors are under no legal obligation to declare the payment of a dividend. For example, the directors will not recommend a dividend if the company is not profitable or if it is profitable, they may decide that the profits should be re-invested into the business.

Right to return of capital

The share capital of a company is not owned by the shareholders, but by the company. This is to protect the creditors of the company who will often have no control over how the company is being managed and operated. If the company becomes insolvent, its creditors will rank ahead of the shareholders in terms of being “paid back” and if necessary, the share capital will be used to do this. For private companies with a small amount of share capital, this might not be of much help to creditors in reality, but the principle remains.

That said, shareholders do have capital rights and if any share capital remains once creditors have been repaid (although this is unlikely in an insolvency context), this will be repaid to the shareholders, usually in proportion to the number of shares that they hold.

Right to information

Shareholders also have rights to receive certain, albeit limited information, about the company. For example, they are entitled to a copy of the company’s annual accounts and any annual report and can request to see a copy of the company’s register of members, any minutes of general meetings and the terms of the directors’ service contracts.

Pre-emption rights

Under the Companies Act, shareholders have a pre-emption right on the allotment of shares. Such rights may also be included in the Articles or any shareholders’ agreement. These rights aim to protect existing shareholders from having their shareholdings diluted, by requiring the company to give existing shareholders a right of first refusal over the allotment of new shares, usually in proportion to their current shareholding.

Pre-emption rights may also apply on the transfer of shares and if so, these and the process to be followed will be set out in the Articles or a shareholders’ agreement. Such rights require any shareholder wishing to transfer their shares to offer them first to the existing shareholders, again, usually in proportion to their current shareholding.

In determining what rights a shareholder has, much will turn on the Articles or any shareholders’ agreement. It is therefore important to check these before taking any action as a shareholder. Our next article will focus on the protections which may be afforded to minority shareholders.

If you have any queries or concerns about your rights as a shareholder, please do not hesitate to get in touch with a member of our Corporate team who would be happy to assist you.

Disclaimer

This note reflects the law as at 19 January 2024. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.

Lifecycle of a Business – Demystifyng the Term Sheet

• 5 December 2023
• News

Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.

With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.

So far, we’ve covered “First Things First” and “Directors: Lights, Camera, Action!” But now, let’s consider financing your business – “Show Me The Money”.

Demystifyng the Term Sheet

You’ve considered your fundraising options, have all your records and documents in place and have an investor in mind, so now it’s time to consider the term sheet.

Your term sheet sets out the fundamental terms of the commercial deal you have struck with your investor(s). Getting it in a shape that everyone is happy with will make for a much smoother execution of your funding round, allowing it to take less time so that you can get back to growing your business.

If you’re bootstrapping your way to an early round of funding, you may think twice about reaching out to an advisor to discuss your term sheet, perhaps wanting to hold off until it’s agreed commercially. I would, however, encourage you to reach out for an initial discussion before signing up to your term sheet, even if just for another perspective on what you’re signing up for.

So, what should a term sheet include?

Valuation

The valuation will set out how much of the equity is being given to the investor(s).

The term sheet may reference the “pre-money” value, being the amount the company is valued at before the funding round closes, and the “post-money” valuation, being the company’s value after (and including) the funding.

Whatever terminology is used, it’s important to understand what you’re agreeing to give to the investor, and whether this is on the basis of the issued share capital or the fully diluted share capital (such that the term sheet may say they’re receiving 10%, but actually, on an issued basis the investor may have more, having factored in the dilutive effects of convertible instruments such as options and warrants).

Option Pool

While the detailed terms of the incentive plan may come later after closing an early round of funding, the term sheet will often set out the percentage option pool to be made available to incentivise key staff. Founders should note how this percentage is calculated (will it dilute everybody or not?).

Investor Shares

The class of shares which investors will receive should have their key rights set out. Is everyone investing for ordinary shares, or will the investors receive preference shares with specific rights?

Preference shares in this context will typically have voting rights and have a priority return over the ordinary shares on a liquidation / exit event. If applicable, the term sheet should set out this priority return (known as a ‘liquidation preference’). It’s customary for investors of preference shares to have a 1* preference, meaning that they receive their investment back first. That said, in recent turbulent markets, there are instances of investors looking for more than this.

Whether they then participate or not in the balance of any proceeds should also be set out, noting that if they are non-participating (as is common), such that they only receive their liquidation preference, they will likely be convertible or entitled to the amount they’d receive had they been ordinary shares (therefore the preference affords the investor a downside protection).

Anti-Dilution

Investors often seek anti-dilution rights, which may include a ratchet such that, if there is a ‘down round’ in the future, the investors are issued more shares in line with that ratchet. Founders should ensure that the term sheet sets out the applicable type of ratchet, and that they understand what it means.

It’s customary for the ratchet to be what is known as a broad based weighted average ratchet.

Founder Vesting

Investors will expect to see good leaver and bad leaver concepts with a vesting schedule for shares held by founders setting out a founder’s entitlement if the founder leaves the company. We would encourage founders to discuss expectations here with the investors early to ensure alignment.

Board Composition

Including who will have a board seat and against what threshold is common. Boards are typically founder-led in their early stages with more board control given up in follow-on rounds as new investors come in and as independent directors are added.

Veto Rights

Investors will typically expect to have a set of investor veto matters, for which a percentage of the investor pool has to vote in favour for the company to action the matter. There may be shareholder matters and also investor director consent matters.

Founders may also wish to seek founder consent matters, although this is not always acceptable to investors.

Warranties

While the detail of the warranties (contractual promises to investors, e.g. that you’re not currently involved in any litigation) will be in the long form documents, we would encourage founders to consider who will be giving warranties and agree this and the overall liability cap upfront with their investors. Previously, founders often had to give warranties by reference to a salary multiple, however more recently the market has moved to having only the issuing company provide the warranties.

Share Transfers

The term sheet should include reference to certain share transfer matters, to the extent they are to apply. For example, pre-emption rights (and who they are for, e.g. everyone or certain investors), drag along rights and tag along rights (and what threshold triggers these rights) and co-sale rights.

Information Rights

While investors may be represented on the board, they will typically expect to have contractual information rights to enhance the limited information a shareholder in a UK company is typically entitled to see. Setting out what investors will receive, and whether this is for all investors or for those that hold a certain percentage of the equity, will allow you to be aware of the administrative burden of complying with this moving forwards.

SEIS / EIS Tax Reliefs

If the round is going to be raising money from investors looking to obtain SEIS/EIS relief this should be acknowledged, and the founders should take advice on what this is likely to mean in terms of structuring and process for them and what the investors may expect.

For more information about these tax reliefs, see here.

Finally, it’s worth being aware that the majority of the term sheet is typically not legally binding, although it may contain certain parts which are, for example, provisions relating to confidentiality and, if you’ve agreed this with your investor(s), exclusivity for a period of time.

Please get in touch if you would like to talk about your funding round and how we can team up to achieve your objectives.

Disclaimer

This note reflects the law as at 30 November 2023. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.