Restaurant business serves up wrong set of articles (Gunewardena v Conran Holdings Ltd)

In this case the High Court considered the operation of ‘leaver provisions’ in a company’s articles of association. The case raises some interesting issues regarding how definitions of 'subsidiary', 'holding company' and 'group' can be construed in a company's articles. The case also considers which articles of association are binding on the company and its shareholders where an incorrect version of the articles is filed with the Registrar of Companies.

Original news

Gunewardena v Conran Holdings Ltd [2016] EWHC 2983 (Ch)

Sir Terence Conran has won a High Court battle against his right-hand man who helped him create his restaurant empire.

In this case the High Court considered the operation of ‘leaver provisions’ in a company’s articles of association. The case raises some interesting issues regarding how definitions of 'subsidiary', 'holding company' and 'group' can be construed in a company's articles. The case also considers which articles of association are binding on the company and its shareholders where an incorrect version of the articles is filed with the Registrar of Companies.

What was the background to the case?

Conran Holdings Limited (CHL) was the holding company for various businesses of Sir Terence Conran. When CHL was formed in 1993, the claimant, Mr Gunewardena (who was then engaged as finance director in Sir Terence's businesses) acquired a holding of shares in the company.

In August 1993 the company adopted new pexels-photo-29346articles of association (1993 Articles), which contained compulsory transfer provisions upon an employee shareholder ceasing to be employed by the CHL group. The price payable for the shares was an amount certified by CHL's auditors as being a fair selling value as between a willing vendor and a willing purchaser.

In October 1995 the Articles were amended to provide, amongst other things, guidance on how the auditors of the company should determine the 'fair price' of the shares on a compulsory transfer. In these circumstances the fair price should be calculated by reference to five times the average annual profit of the last two accounting periods) (the Five Times Profits valuation).

In March 1998 further amendments to the Articles were proposed, none of which affected the compulsory transfer provisions. A special resolution was passed approving the new articles. However, the version of the Articles that were filed with Companies House (March 1998 Filed Articles) did not reflect the 1993 Articles as amended in 1995 and then as further amended in March 1998; they were instead an attempt to merge the 1998 resolution with the unamended 1993 articles (missing out the effect of the 1995 amendments).

In 2005 CHL decided that it did not wish to continue to run its restaurant business and decided to dispose of its restaurants. A transaction was entered into pursuant to which the restaurants were placed into CGL Restaurant Holdings Ltd (CGL). CHL had a 51% shareholding in that company and Mr Gunewardena and his partners and financiers had 49%. Mr Gunewardena ceased to be an employee (CEO) of CHL but became an employee of CGL.

In April 2013 Mr Gunewardena and a private equity house acquired CHL's remaining 51% in CGL. That terminated CHL's interest in CGL and, according to CHL, meant that Mr Gunewardena was no longer employed by the CHL group. That was said by CHL to give rise to a deemed transfer notice in respect of Mr Gunewardena's shareholding in CHL and so CHL has sought to rely on that mechanism, and on the Five Times Profits valuation provision as fixing the price. The auditors had certified that there were no profits in the two relevant periods (there were in fact losses), which meant that the price should have been nil, but CHL resolved to pay the par value of the shares (£1,254) and claimed to transfer the shares under the mechanism in the articles.

What were the key issues in the case?

There were four key issues in the case:

  • Was CGL a subsidiary of CHL immediately prior to the ultimate sale to CGL in 2013? If it was, then Mr Gunewardena was deemed to have given a transfer notice in 2013
  • Were the true Articles of the company those in the March 1998 Filed Articles by virtue of their filing? This went to the basis of valuation of Mr Gunewardena's shares
  • If not, were the March 1998 Filed Articles the true Articles of the company by virtue of agreement, acquiescence or some other form of informal adoption? This again went to the basis of valuation of Mr Gunewardena's shares
  • Had the company followed the correct procedure specified by the Articles?

Was CGL a subsidiary immediately before the transfer by CHL of its shares in 2013?

Immediately before the sale of a large part of the restaurant business in 2006, Mr Gunewardena was the CEO of, and employed by, CHL. On the sale he ceased to occupy that position, but became the CEO of CGL. Mr Gunewardena argued that at that point he ceased to be employed by 'the Group' within the meaning of the Articles because CGL was not, on the facts, a subsidiary of CHL.

The Articles defined 'the Group' to include its 'subsidiaries' and that term was given its Companies Act 1985 (CA 1985) definition. CA 1985, s 736(1), as amended, provided:

'A company is a 'subsidiary' of another company, its 'holding company', if that other company...holds a majority of the voting rights in it…'

CA 1985, s 736A(2) provided:

'In section 736(1)(a)...the references to the voting rights in a company are to the rights conferred on shareholders in respect of their shares. to vote at general meetings of the company on all, or substantially all, matters.'

On this footing CGL was plainly said to qualify as a subsidiary. CHL owned 51% (actually 51.2%) of the ordinary shares, and could vote at general meetings on all, or substantially all, matters.

The claimant argued that from the date of the 2006 transaction onwards CGL was not regarded as a subsidiary but was treated as a joint venture company instead, or that it was essentially autonomous. Under certain shareholder agreements, various veto rights existed which deprived CHL of a lot of the powers that it would otherwise have been able to exercise by virtue of its majority shareholding. Furthermore, in the accounts of CHL, CGL was described as an investment or joint venture and not as a subsidiary.

The High Court dismissed these arguments commenting that they failed to distinguish between what 'subsidiary' meant for the purposes of the Articles, and what sort of label would be right to apply to the proper accounting treatment of CGL in the consolidated accounts of CHL. For the purposes of the Articles, CGL was clearly a subsidiary of CHL. The Articles had to be construed as at the date they came into force, at which point of time CGL did not even exist. The meaning of the words in the Article could not change according to changing circumstances; they could not change by reference to how certain people regarded a relationship; and they could not change depending on how accounting standards (which might themselves change over time) might view the situation.

CGL was plainly a subsidiary of CHL until the sale of the balance of the shares in CGL in 2013, and at that point Mr Gunewardena ceased to be employed by a company that was a subsidiary. He therefore gave a deemed Transfer Notice.

What were the articles after the March 1998 EGM—the effect of filing?

This question went to the valuation technique to be applied under the compulsory purchase mechanism. If the claimant's submissions were correct the 'fair selling price' test applied without the Five Times Profits methodology. If the defendant was right then the Five Times Profits methodology was applied to determining the fair selling price.

The claimant argued that the effect of what happened in March 1998 was that the March 1998 Filed Articles were thereafter the true Articles of Association of CHL, essentially by virtue of their being filed.

The High Court dismissed this argument saying that it failed to distinguish between the Articles as a contractual or legal concept, and the Articles as a piece of paper designed to capture (or evidence) that concept. It also over-stated the significance of registration of amended Articles and misapplied the concept of rectification.

CA 1985, s 7 allowed for the amendment of a company's articles by special resolution. No other method of altering a company's articles was suggested elsewhere in the CA 1985.

The Articles were what the members had resolved on from time to time, whether originally or by an amending special resolution. If the members resolved on an amendment by special resolution, the Articles, as amended, became the new contract and the new Articles. The Articles would essentially take effect as such immediately. Their status as articles did not depend on registration. If the wrong form of articles was filed then this would be in breach of the statutory obligations on filing, but the articles as resolved on would remain the articles. Any other conclusion would be contrary to the statute which permitted only one mechanism for the amendment of articles—a special resolution.

Adoption by acquiescence

The claimant also argued that the March 1998 Filed Articles were acquiesced in and acted upon by all shareholders after they were filed as if they were the true articles and had thereby become binding.

Here the claimant referenced the Hong Kong case of Ho Tung v Man On Insurance Company Limited [1902] AC 232. In that case the unsigned articles of a company incorporated in Hong Kong were irregularly registered along with its memorandum of association; but it appeared that they had for nineteen years been published, acted on without objection, and from time to time amended and added to by special resolutions. The Privy Council held that the unsigned Articles should be treated as the Articles by virtue of acquiescence and implied agreement.

The High Court commented that the Ho Tung case was a manifestation of the 'Duomatic principle', which had been summarised in the following terms in Re Duomatic Ltd [1969] 2 Ch 365:

'Where it can be shown that all shareholders who have a right to attend and vote at a general meeting of the company assent to some matter which a general meeting of the company could carry into effect, that assent is as binding as a resolution in general meeting.'

This argument failed on its facts. The High Court found there was no case for saying that any of the shareholders apart from Mr Gunewardena (and query even him) acted on the footing that they agreed, or acquiesced in, the fact that the March 1998 Filed Articles were those governing the company.

Had the company followed the correct procedure?

The claimant's final argument was that if the company and the members were entitled to invoke the Five Times Profits valuation, then on the figures the consideration payable to Mr Gunewardena was nil. However, the directors agreed to offer Mr Gunewardena the par value of the shares (£1,254). That was operating the mechanism incorrectly, so the exercise could not stand. In other words, a proposal to pay him too much meant that the exercise failed.

The High Court dismissed this argument. The company's compulsory transfer notice had enclosed the auditors' certificate which carried out a calculation which arrived at a minus figure, but from which it was plain that the value of the shares was zero. The transfer notice then offered more than zero for the shares. Read sensibly, the company was giving notice that it was prepared to purchase at zero but was in fact offering more than that. The offer to a seller of more than he is entitled to could not mean that the notice was bad. If it had offered less than the certified sum then the position would be otherwise. However, the specification of £1,254 should be taken to be an offer of nil with a further proposal to purchase at more than that.

Application to Companies Act 2006

Although many aspects of the judgement related to provisions under CA 1985 (and in the Ho Tung case, the Hong Kong Ordinance of 1865), the principles are likely to be equally applicable to the equivalent provisions in the Companies Act 2006.

By Darius Lewington

Relevant Articles
Area of Interest