England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM MR JUSTICE LADDIE
CHANCERY DIVISION

		Royal Courts of Justice Strand, London, WC2A 2LL
		10th April 2003

Lord Justice Mummery :

Introduction

1. This appeal from the order of Laddie J dated 31 July 2002 is about the application of ss 151 and 152 of the Companies Act 1985 (the 1985 Act). The provisions date from the Companies Act 1929 and have been modified by subsequent Companies Acts. In response to notorious scandals and great dissatisfaction caused by the speculative activities of asset strippers after the First World War, Parliament decided to criminalise the giving of financial assistance by a company for the purpose of acquiring its own shares: see Re VGM Holdings Limited [1942] Ch 235 at 239 per Lord Greene MR.
2. The most up-to-date account of the intentions of Parliament, the legislative history of the provisions and their judicial interpretation is in the leading judgment handed down by Arden LJ (Buxton and Ward LJJ concurring in separate judgments) in Chaston v. SWP Group plc [2002] EWCA Civ 1999 (Chaston). The judgment comments on aspects of Laddie J's decision in this case and quotes from a commentary on it in Buckley on the Companies Acts (15^th Ed) at paragraph 151.21A. An unusual situation has now arisen in which both sides confidently claim that the Court of Appeal in Chaston has already treated the first instance decision in this case in a manner consistent with, and even supportive of, their competing arguments on this appeal.
3. The disputed questions have arisen on applications for summary judgment by the defendants in this action and in six related sets of proceedings. The actions have been brought against them by the claimant target company, acting by its liquidator. Breaches of the statutory prohibition are alleged to have occurred in 1995.
4. The judge granted the applications, struck out the Particulars of Claim and dismissed all the actions. The claimant company appeals, contending that the actions have a real prospect of success and that they should be allowed to proceed to trial; alternatively, that summary judgment should be given against the defendants. There is an appeal against the order striking out a claim for knowing receipt against one of the defendants. There is also a respondent's notice seeking to uphold the judge's order on different or additional grounds.

The Facts

5. The claimant company is now called MT Realisations Limited (MTR). In 1994 MTR was a loss making, insolvent subsidiary company in the Digital group of companies, suppliers of Compaq computer equipment. MTR was dependent on substantial funding (to the tune of about £8m) in the form of loans advanced under loan agreements by the holding company in the group, Digital Equipment Co Limited (Digital UK). The loans were re-payable on demand. The defendants claimed that MTR's liability to repay the loans made by Digital UK was secured by debentures created by MTR in favour of Digital UK in 1992 and 1994. This was also expressly alleged in MTR's Particulars of Claim (paragraph 12.2), as was the assignment of the benefit of the security documents attached to the Loan Assignment by Digital UK referred to below (paragraph 13.4).
6. In the autumn of 1994 there were negotiations for the sale of the shares in MTR. Under Heads of Agreement dated 9 December 1994 the whole of the issued share capital in MTR was to be sold for £6.5m on the basis that the inter-company loan of £8m would be released. The deal was then re-structured so that there were two agreements.
7. The first was a Stock Purchase Agreement dated 22 December 1994 under which MTI Holdings (UK) Ltd (MTI), which is related to an American company, Management Technology Inc, acquired the shares in MTR from the holding companies, for £1. It was recited that the acquisition of the stock was subject to the obligations of MTI to pay the purchase price for the Loan Assignment.
8. The second was a Loan Assignment also dated 22 December 1994 under which MTI agreed to pay to Digital UK a discounted price of £6.5m, payable by instalments, for an assignment to it of the £8m loans repayable to Digital UK by MTR. It was recited that, as security for its obligations under the loan agreements, MTR had granted to Digital UK a security interest in all its tangible and intangible assets. The Loan Assignment referred to "Security Documents" being attached agreements entered into by MTR for all the sums payable to Digital UK under the loan agreements. Debentures containing fixed and floating charges granted by MTR to Digital UK to secure inter-company loans were dated December 1992 and 2 April 1994 and were annexed to the Loan Assignment.
9. It is common ground that the transactions did not at that date involve the giving of any "financial assistance" by MTR for the acquisition of its shares. It is, however, contended by MTR that the liability to pay the sum of £6.5m for the assignment of the loans by Digital UK to MTI was incurred by MTI "for the purpose of" the acquisition of the shares in MTR because, but for the acquisition of the shares in MTR, MTI would not have entered into the Loan Assignment. This analysis of the position is disputed by the defendant Digital UK and other members of the Digital group.
10. MTI was unable to meet its obligation to pay instalments due under the Loan Assignment. The terms were varied in March 1995. Then a Re-scheduling Agreement was made on 29 August 1995. The effect of that agreement was that further time was allowed for payment of the purchase price under the Loan Assignment. The method of payment was also varied so that sums due from Digital UK (or any member of its group), to MTR, would be directed to be paid to Digital UK, instead of to MTR, in reduction of the outstanding instalments of the purchase price under the Loan Assignment.
11. MTR contends that this re-arrangement constituted the giving of "financial assistance" by MTR. That was unlawful, as the assistance was given for "the purpose of reducing or discharging the liability so incurred" contrary to section 151(2) i.e. the liability of MTI under the Loan Assignment, which had been "incurred… for the purpose of" the acquisition by MTI from Digital UK of the shares in MTR.
12. The total of £2,131,124.20 directed to be paid to Digital UK included substantial sums owed by companies in the Digital group, to MTR. As the judge explained (paragraph 10)

" Therefore, in respect of these debts, sums owed by companies in the Digital group to MTR…were set off against what MTI owed Digital under the Loan Agreement, thereby facilitating the reduction of MTI's indebtedness under the latter agreement. It is this mechanism for the reduction of MTI's indebtedness which lies at the heart of the various claims made by MTR… in these proceedings."

13. In this way sums of money due to MTR from companies in the Digital group, were made available to discharge liabilities incurred by MTI to Digital UK under the Loan Assignment, which was entered into when MTI agreed to purchase from Digital UK the shares in MTR.
14. By September 1996 all sums owing by MTI under the Loan Assignment were treated as paid.
15. MTR subsequently went into liquidation. It claimed through its liquidator that the re-scheduling of MTI's obligations by way of set off in this agreed fashion constituted an offence under s 151, with the result that the agreement of 29 August 1995 is liable to be set aside and that all the debts owing by members of the Digital group to MTR are to be treated as still due and owing by members of the Digital group, to MTR. Alternatively, damages are claimed for the loss suffered by the cancellation of the debts due to MTR. The claims against the group member in question are for knowing receipt based on breach of fiduciary duty on the part of the directors of MTR in allowing its assets to be used to discharge the liabilities of another company, MTI; for unlawful interference with the contractual relations between MTR and the companies in the Digital group, who were induced not to pay to MTR what was due to it; and absence of consideration for the transfer to of the debts due to MTR.

The Judgment

16. Laddie J held that there was no breach of s 151. He struck out MTR's Particulars of Claim and dismissed all the claims in this action and in six related actions by the liquidator of MTR against Digital UK and its associated companies.
17. He held that MTR did not give financial assistance "for the purpose of" acquiring its own shares. The agreement by MTI to pay £6.5m under the assignment was not a liability incurred "for the purpose of" the acquisition of MTR's shares. There was no evidence that MTI could not pay the price of £1 for the shares or that MTR's shares were worth more than £1. The £6.5m was agreed to be paid for the acquisition of the inter-company loans, not for the acquisition of the shares in MTR.
18. On the issue whether the agreement of 29 August 1995 was made for the purpose of discharging a "liability incurred" for the purpose of acquiring shares in a company, he drew a distinction between "incentives to enter into an agreement or concurrent benefits" and the acquisition of shares in MTR.
19. On the issue of giving "financial assistance", he held that there was no distinction between a company which had net assets and a company, like MTR, which had no net assets. What mattered was that there was financial neutrality. In this case there was no net flow of assets from MTR to MTI. No financial liability was adopted by MTR for the benefit of MTI. MTR was not "giving" anything financial to MTI. MTI was not "receiving" any assistance from MTR. So no financial assistance was given in breach of s 151.
20. He also summarily rejected the other heads of claim, holding that the scheme was for the benefit of MTR and that there was no breach of fiduciary duty, unlawful interference with contractual relations or lack of consideration for the assignment to Digital UK of the debts due to MTR.

The Legislation

21. Section 151 provides that financial assistance by the target company, whether given before (subsec (1)) or after (subsec (2)) the acquisition of the shares, is generally prohibited-

" (1) Subject to the following provisions of this Chapter, where a person is acquiring or is proposing to acquire shares in a company, it is not lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of that acquisition before or at the same time as the acquisition takes place.

(2) Subject to those provisions, where a person has acquired shares in a company and any liability has been incurred (by that person or any other person), for the purpose of that acquisition, it is not lawful for the company or any of its subsidiaries to give financial assistance directly or indirectly for the purpose of reducing or discharging the liability so incurred.

(3) If a company acts in contravention of this section, it is liable to a fine, and every officer of it who is in default is liable to imprisonment or a fine, or both."

Section 152 contains provisions which, without defining the expression "financial assistance," define the different prohibited ways in which financial assistance can be given.

" (1) In this Chapter-

(a) "financial assistance " means-

(i) financial assistance given by way of gift

(ii) financial assistance given by way of guarantee, security or indemnity, other than an indemnity in respect of the indemnifier's own neglect or default, or by way of release or waiver,

(iii) financial assistance given by way of loan or any other agreement under which any of the obligations of the person giving the assistance are to be fulfilled at a time when in accordance with the agreement any obligation of another party to the agreement remains unfulfilled, or by way of the novation of, or the assignment of rights arising under, a loan or such other agreement, or

(iv) any other financial assistance given by a company the net assets of which are thereby reduced to a material extent or which has no net assets.

(2) In subsection (1)(a)(iv), "net assets" means the aggregate of the company's assets, less the aggregate of its liabilities…"

Submissions of MTR

22. Mr Charles Purle QC appeared on behalf of MTR, acting through its liquidator. The actions are brought with the support of and for the benefit of MTR's creditors. The principal creditor is the Inland Revenue. It has large preferential claims in the liquidation.
23. Mr Purle contended that there was a real prospect of establishing at trial that there had been breaches of s 151 and 152. The position was that MTI acquired the shares in MTR from Digital UK. The acquisition of the shares in MTR was the purpose, or, at the very least, one of the purposes, for which MTI incurred the liability to pay Digital UK £6.5m for the assignment of the loans totalling £8m due from MTR to Digital UK. There was no commercial purpose in MTI agreeing to take an assignment of the loans apart from its acquisition of the shares in MTR. But for the acquisition of the shares in MTR, MTI would not have entered into the Loan Assignment.
24. The set-off arrangements in the Re-scheduling Agreement made on 29 August 1995 reduced or discharged the liability incurred by MTI to pay £6.5m. That involved "financial assistance" given by MTR by re-routing to Digital UK debts due to MTR for the purpose of discharging the liability of MTI under the Loan Assignment . That liability was incurred for the purpose of facilitating the acquisition of the shares in MTR. The result was equivalent to payment by MTR for its own shares.
25. Mr Purle submitted that the judge approached the matter wrongly by regarding it as necessary for the financial assistance to be given "for the purpose of" the acquisition; by treating the liability of £1 as the only liability incurred "for the purpose of" the acquisition of the shares in MTR; and by holding that a net diminution or reduction in net assets had to be shown.
26. Mr Purle submitted that the set off arrangements had as their purpose the reduction or discharge of a liability incurred for the purpose of the acquisition of the shares. The set off arrangements amounted to financial assistance, being either a "gift" or payments by MTR, being a company which had no net assets. The result was that s151 had been contravened and that there had been no valid discharge of the debts in question.

Discussion

27. I have reached the same conclusion as Laddie J, though by a slightly different route. This is largely explicable by the fact that, as quite often happens, the arguments were deployed on the appeal with a different emphasis than in the court below.
28. On the "commercial realities of the transaction" approach to s 151,as expounded by Hoffmann J in Charterhouse Investment Trust Ltd v. Tempest Diesels Ltd [1986] BCLC 1 at p.10f-11c (a case on s 54 Companies Act 1948) and followed in later cases, such as Chaston, no "financial assistance" was, in my judgment, given by MTR to MTI "for the purpose of" reducing or discharging a liability incurred for the purpose of the acquisition of shares in MTR.
29. The legal analysis shortly stated as follows is sufficient to dispose of the appeal:-.

(1) The relevant date for determining whether there has been a breach of s151 is 29 August 1995. It is not suggested that any financial assistance was given by MTR to MTI when the Stock Purchase Agreement and the Loan Assignment were entered into on 22 December 1994 or at any other date before the Re-scheduling Agreement. What was done after 29 August 1995 was pursuant to the terms of the Re-scheduling Agreement.

(2) The breach of s 151(2) is said to have resulted from the agreement that sums due to MTR should be diverted to Digital UK, not for the benefit of MTR but to give financial assistance to MTI so that it could pay off the sum owed to Digital UK under the Loan Assignment. In order to appreciate the "commercial realities of the transaction" it is necessary to examine more closely MTI's legal rights against MTR in respect of the inter-company indebtedness at the date of the Re-scheduling Agreement.

(3) Under the pleaded debentures of 21 December 1992 and 2 April 1994 the book debts of MTR were subject to fixed and floating charges in favour of Digital UK to secure the sum of £8m repayable on demand. MTR itself pleaded that the benefit of the security was transferred to MTI on 22 December 1994. Although there is no evidence that the charges were ever registered under s 395 of the 1985 Act, failure to register does not avoid the charges as against the MTR before its liquidation or affect the enforceability of the charges against MTR before liquidation by all the remedies of a mortgagee, such as the appointment of a receiver to receive monies due to MTR and to apply them in reduction of the sum secured. Nor would failure to register invalidate the contractual obligation to repay the sums secured: see, generally, Gore-Browne on Companies (44^th Ed) Vol 1 para 18.10.

(4) The legal position at the date of the Re-scheduling Agreement was that MTI was accordingly entitled to take steps to enforce its rights as a secured creditor against MTR in respect of sums due to MTR from Digital UK and its associated companies. By enforcing its security rights as chargee it would recover its legal entitlement, rather than be the recipient of "financial assistance" from MTR as chargor and debtor. The overall net effect of the Re-scheduling Agreement was simply to short-circuit the position. Instead of MTR receiving sums due to it from Digital UK and its associated companies and then paying them to its parent, MTI, in repayment of the inter-company loans, it was arranged that what was due for payment to MTR would instead be paid direct to Digital UK, to whom MTI owed the instalments of the purchase price under the Loan Assignment.

(5) Both as a matter of the "commercial realities of the transaction" and of legal principle such an arrangement did not involve MTR in giving "financial assistance " to MTI within the meaning of s 151(2). Quite apart from the point that it did not have any negative impact on MTR's overall net balance sheet position, the relevance of which is disputed, there was no "gift" by MTR to MTI. As MTI was in the position of a secured creditor of MTR, it was entitled to help itself by exercising its security rights over the book debts due to MTR from Digital UK and other companies in its group. As was said in the decision of the Federal Court of Australia in Sterileair Pty Ltd v. Papallo ( NG 278 of 1998: 16 November 1998) " ' Assistance' involves something in the nature of aid or help. It cannot exist in a vacuum; it must be given to someone." In this case nothing was given by MTR to MTI, which it had not already acquired as its own resource by assignment from Digital UK in order to secure performance of the obligation to re-pay the inter-company loans due on demand from MTR to Digital UK. No financial assistance was being given to MTI by MTR out of its own free assets or resources.

30. It was also argued that the existence of the security for debts repayable on demand was relevant to the "purpose" point. The Re-scheduling Agreement was for "the purpose of" paying the balance of the purchase price for the assignment of the secured loans, not the purchase price of acquiring the shares in MTR. The commercial substance of the payment of £6.5m was the assignment of the loans. MTI would not have paid that sum for the shares. I find this a less persuasive point, but it is unnecessary to express any final view on it, as the conclusion on the " financial assistance" point is sufficient to justify the dismissal of the appeal.

Chaston

31. Both sides made submissions on Chaston in which Court of Appeal held that financial assistance was given in breach of s 151 when the claimant company committed itself to pay accountants' fees in respect of their services in reporting on a due diligence exercise, which was carried out for the purpose of furthering another company's acquisition of shares in the claimant's parent company.
32. Arden LJ emphasised the importance of focusing on the "commercial substance of the transaction" in each case (paragraphs 32 and 38-40). In her discussion of the rival submissions Arden LJ referred to the authorities in detail, including the decision of Laddie J in this case. In the course of her judgment she concluded that, as a matter of the commercial substance and reality, financial assistance for the purpose of acquiring its shares may have been given by a company in breach of s 151 on the facts of the particular case, even though (a) it could not necessarily be shown that the company being acquired has suffered any detriment; (b) the assistance was given in advance of the transaction, rather than in the course of it; (c) the assistance may merely have acted as an inducement to the transaction; (d) the assistance may have no impact on the share price;(e) the assistance was given by the target company in circumstances where its directors had acted bona fide in the best interests of that company; (f) the assistance was given to the parties to the transaction rather than to the target company itself; and (g) only one of the purposes for which the transaction was carried out was to assist the acquisition of shares
33. Mr Purle submitted that Chaston supported MTI's case. He pointed out that Arden LJ expressly disagreed with two aspects of the judgment of Laddie J in this case: (a) in so far as he held (in paragraph 50 of his judgment) that detriment to the target company is required before financial assistance can be found to be given; and (b) in so far as he held (in paragraph 30 of his judgment) that assistance which acted as an incentive to enter into an agreement or concurrent benefits was distinct from assistance for the acquisition of the shares in the target company and could never amount to financial assistance in breach of s 151: see paragraphs 41 and 44 of Arden LJ's judgment.
34. Mr Purle submitted that the approach of the Court of Appeal in Chaston supported MTI's case that the effect of the set off arrangements in this case was to discharge the existing financial liability of MTI in respect of the acquisition of the shares and was clearly financial assistance in both the commercial and legal sense. He highlighted the situation of MTR as a company having no net assets and so falling within s 152(1)(a)(iv). The effect of the set offs was that MTR paid for part of the exercise of the acquisition of shares in it. MTI's'outstanding liability to Digital UK was paid by MTR. That was for the purpose of the acquisition of the shares in MTR, as the liability to pay for the loan assignment was incurred for the purpose of furthering the acquisition of the shares in MTR.
35. Mr Marshall, on behalf of Digital UK, had no difficulty in distinguishing the decision in Chaston from the facts of this case or in submitting that the reasoning in Chaston does not require the court to conclude that there has been a breach of s 151. As he pointed out, Chaston was a case in which, on the facts, a liability to pay money was incurred by a company (and payment was in fact made by the company) in order to facilitate the purchase of shares in it. In this case MTI took an assignment of secured loans made by Digital UK to MTR at the same time as it purchased the shares in MTR. As assignee of the secured loans, MTI had the right to make an immediate demand for repayment of the loans, to enforce its security over debts due to MTR from the Digital Group and to use those sums to pay the debt due from it to Digital UK for the acquisition of the secured loans. For the reasons already explained, that did not, as a matter of commercial substance and reality, constitute financial assistance by MTR to MTI for the purpose of acquiring shares in MTR. I would add that each case is a matter of applying the commercial concepts expressed in non-technical language to the particular facts. The authorities provide useful illustrations of the variety of fact situations in which the issue can arise, but it is rare to find an authority on s 151 which requires a particular result to be reached on different facts.

Claim for Knowing Receipt

36. MTR also appeals against the order of Laddie J striking out the claim for knowing receipt against Digital UK, but, as Mr Purle accepted, that point only becomes relevant if section 151 was breached or if there was some other breach of fiduciary duty, or both.
37. The other claims by MTI against Digital UK were summarised in paragraph 11.4 of the Particulars of Claim:

" Any benefit of, or interest in, such debts [ i.e. the debts owed to MTR] as was acquired by Digital UK in the knowledge of the breach by the directors of [MTR] of their fiduciary duties to [MTR] in procuring or permitting the assignment or the purported assignment of such debts, or any interest therein, to Digital UK and/or in failing to seek the payment of such debts to [MTR], for the unlawful purpose of giving effect to the set off or purported set off, and it would be unconscionable for Digital UK to retain the benefit of such debts, or any interest therein: Digital UK accordingly holds such debts, or any interest therein on constructive trust for [MTR].

38. The allegations were repeated in paragraph 25 of the Particulars of Claim as constituting breach of fiduciary duties owed by to MTR by its directors, constructive trust, absence of lawful consideration and interference with contractual relations. They were amplified in a response for further information on 27 February 2002.
39. Mr Purle concentrated on the claim for knowing receipt, submitting that it raised a triable issue which was unfit for summary treatment and turned on whether the conscience of Digital UK was affected by knowledge of facts, which made the transaction a breach of duty, for example because it contravenes s 151. Digital UK had the requisite knowledge: it was a party to both agreements in December 1994 and to the set off arrangements in August 1995, which were negotiated by it with MTI, and to the correspondence giving effect to the arrangements. It also knew of MTR's financial difficulties and that its continuance as a going concern was dependent on the support of the parent company.
40. The knowing receipt claim is, like all the other claims, expressly or implicitly premised on the alleged unlawfulness of the assignment of debts by the Re-scheduling Agreement as being for the purpose of giving financial assistance for the purpose of discharging, or reducing, the liabilities of MTI under the December 1994 agreements. As, for the reasons stated above there is no breach of s 151, those claims have no real prospect of success and the judge was right to strike them out.

New Points

41. In his reply and in a written addendum submitted after the oral hearing Mr Purle raised a number of points that were not raised below, or in the Appeal Notice or in his skeleton argument.

(1) It was contended that the security created by the debentures was only a floating charge over the book debts: Agnew v. CIR [2001] 2 AC 710. To that extent it would have been secondary to the claims of the preferential creditors. The validity of this new point was disputed by Mr Marshall. His response was that, even if legally correct as a general proposition, the point had no substance on MTR's own evidence. It showed that the assets were sufficient to cover the amount of the debts assigned to Digital UK and all the potential claims of the preferential creditors. The preferential debts would not have stood in the way of a receiver realising assets to meet the debt owing by MTR to MTI.

(2) It was contended that MTI had no security in respect of any debt due to it as at the date of the set-off arrangements in August 1995 or afterwards. Mr Purle commented, by reference to the evidence and the documents, that the two debentures annexed to the Loans Assignment did not appear to have been executed; that the Loan Assignment did not identify the "security interest" referred to in it; that one of the debentures was prepared retrospectively and was mis-dated; and that no debentures had been registered. This contention was contrary to the case currently pleaded by MTR. The argument below and on this appeal was conducted by each side on the basis of the pleaded case. There has been no formal application, supported by evidence, for permission to amend the pleadings. Judgment must be given on the case as currently pleaded. Mr Purle accepted that the contention that there was no secured indebtedness to assign in 1994 was not presently open to him on the pleadings, although he also stated that he did not accept that the pleadings required the Court to proceed on the basis that MTI remained a secured creditor at the time of the set off arrangements. His primary case, as argued below, remained that no corresponding credit was given by MTI to MTR. He indicated in his reply submissions that, if his appeal was dismissed, he wished to make an application to the court of first instance for permission to amend the Particulars of Claim.

Result

42. As the new points do not affect my earlier conclusions, I would dismiss the appeal.

Lord Justice May

43. I agree.

The President

44. I also agree.