Summary

There had been no knowledge or intention that the sale of shares by one company to another had been below their market value and no reason to doubt the genuineness of the transaction as a commercial sale, even though the sale price had been calculated on the basis of a misunderstanding by all concerned, the share sale had been genuine, lawful and intra vires, even if it was at an undervalue.

Facts

The appellant company (P) appealed against part of a decision of the judge [ (2008) EWHC 2577 (Ch) ] dismissing its claim against the respondent company (M) for the return of shares previously held by P in one of its subsidiary companies (Y), or for compensation. P had entered into a sale and purchase agreement with the M for the sale of shares in Y. The sale price was calculated on the basis of Y's open market value, from which a sum of £4 million was subtracted in the belief that P had given an indemnity or counter-indemnity under which a repairing liability would ultimately fall on P. As part of the transaction, P was to be released from that liability. However, there was no such indemnity liability and nothing from which P could be released, and consequently there was no justification for the reduction in the sale price of the shares. P issued proceedings against M alleging, inter alia, that as the sale of the shares had been at a gross undervalue, the sale should be held ultra vires on the ground that it was, in substance, an unlawful distribution in disguise. It was P's case that it was significant that, at the date of the sale, both it as vendor, and M as purchaser, had been under the control of the same holding company (T), and the sale terms had been negotiated by a director of both P and M who was a close associate of the chairman of T's ultimate parent company. The judge found that, even on the assumption that the share sale was at an undervalue, the sale was not ultra vires but a genuine sale as it had neither purported to be nor was it in reality a distribution of P's assets to, or at the behest of, one of its members. P contended that a company could not, in the absence of the leave of the court or a special procedure such as a winding up, return its capital or distribute its corporate assets to its shareholders: that amounted to an ultra vires act. P submitted that the negotiator of the sale ought to have known that the transaction was at an undervalue, and that his belief that it was at market value was unreasonable and negligent. P further contended that the sale of its shares in Y at an undervalue was a "distribution" of a company's assets to a member contrary to the Companies Act 1985 s.263(1), and was therefore ultra vires and unlawful under statute also.

Held

The common law rule devised for the protection of the creditors of a company was well settled: a distribution of a company's assets to a shareholder, except in accordance with specific statutory procedures, was a return of capital which was unlawful and ultra vires the company. Whether or not the transaction was a distribution to shareholders did not depend exclusively on what the parties chose to call it: the court would look at the substance rather than the outward appearance, Aveling Barford Ltd v Perion Ltd (1989) 5 BCC 677 Ch D applied. The rule against distributions of capital to shareholders did not apply in the instant case simply because, through the connection between T and the negotiator of the sale, P's shares in Y were sold to M at an undervalue. Nor was the sale rendered unlawful because the negotiator ought to have appreciated that the sale was at an undervalue. The fact was that he had not. A sale of a company's asset would not be a genuine sale where it was known and intended to be a sale at an undervalue: that was what made it an unlawful distribution and ultra vires, Aveling applied. There had been no knowledge or intention on the part of the negotiator to dispose of the shares at an undervalue and no reason to doubt the genuineness of the transaction as a commercial sale of Y's shares, even though the sale price had been calculated on the basis of a misunderstanding by all concerned. The judge had, therefore, been right in holding that the sale of Y's shares was not a disguised distribution of assets either in breach of the common law rule or in breach of s.263 or as being for a collateral purpose. The payment could only properly and objectively be characterised as consideration for the sale of an asset without any element of gratuitous benefit and P had failed to show that the judge was wrong in holding that the sale of its shares in Y was genuine, lawful and intra vires, even if it was at an undervalue.

Appeal dismissed