England and Wales Court of Appeal (Civil Division) Decisions

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM THE HIGH COURT OF JUSTICE
CHANCERY DIVISION
MR DAVID DONALDSON QC sitting as a Deputy High Court Judge
HC06C03470

		Royal Courts of Justice Strand, London, WC2A 2LL
		26/06/2009

Lord Justice Mummery :

Introductory

1. This appeal raises a short, but quite basic, company law point. What are the circumstances in which a sale of assets at an undervalue by a company to, or at the behest of, a shareholder in the company should be held ultra vires on the ground that, in substance, the sale is an unlawful distribution in disguise?
2. The order under appeal is that of Mr David Donaldson QC dated 15 October 2008. Sitting as a deputy judge in the Chancery Division he dismissed claims by Progress Property Company Limited (PPC), a company holding properties through wholly owned subsidiaries, against Moorgarth Group Limited (Moorgarth). The principal claim was for the return of shares previously held by PPC in one of its subsidiaries, YMS Properties (No 1) Limited (YMS1), or for compensation.
3. No less than three actions were tried over a period of 14 days, which is an unusual stint to be undertaken by a deputy judge. Other parties and allegations were involved in the actions, mainly in connection with unsuccessful claims against a director of PPC for breach of fiduciary duty. The decisions on those and other claims have not been appealed.
4. Permission to appeal, which the deputy judge refused, was granted by Jacob LJ on 11 December 2008. The appeal is on one point only: whether PPC's sale of its shares in YMS1 to Moorgarth was ultra vires. Although it was accepted that the transaction took the form of a sale of the shares, PPC alleged that the price was a gross undervalue and that the transaction was, in truth, a dressed-up unlawful distribution of its assets.
5. The common law rule on the maintenance of the capital of a company and against distributions to members was expounded by two future Law Lords each held in high regard for wise judgments on company law - Oliver J in Re Halt Garage (1964) Limited [1982] 3 All ER 1016 and Hoffmann J in Aveling Barford Limited v. Perion Limited & Ors [1989] BCLC 626. Those judgments were cited in support of an attack on the validity of the sale of PPC's shares in YMS1.
6. The sale and purchase agreement was made on 20 October 2003 at an agreed price of £63,225.72. The sale price was calculated on the basis of the open market value of the YMS1 properties (£11.83m), from which there was subtracted liabilities for creditors approaching £8m and the sum of £4m in respect of a repairing liability. The subtraction of £4m was made in the belief that PPC had given an indemnity or counter-indemnity under which that liability would ultimately fall on PPC. As part of the transaction that liability of PPC was to be released. In fact, it turned out that there was no such indemnity liability and there was nothing from which PPC could be released. In consequence there was no £4m to subtract from the value of the YMS1 properties. There was no justification for the reduction in the sale price. So it was said that the sale of the shares was at a gross undervalue.
7. PPC adduced expert evidence at trial that the sale consideration was an undervalue by as much as between £2m and £4m. This was disputed by Moorgarth which also relied on expert valuation evidence. However, the deputy judge did not find it necessary to decide the valuation point. For the purposes of ruling on PPC's ultra vires claim he was prepared to assume that the share sale was at an undervalue. He concluded that, even on that assumption, the sale of the shares was not ultra vires PPC. It was a genuine sale. It neither purported to be nor was it in reality a distribution of PPC's assets to, or at the behest of, one of its members.
8. As for the remaining issues litigated at trial the deputy judge rejected allegations of breaches of duty on the part of PPC's directors. Any breaches of directors' duties were ratifiable by the shareholders in general meeting. They were in fact so ratified. It was agreed that ultra vires acts of PPC were different. They could not be ratified: see Rolled Steel Products (Holdings) Limited v. British Steel Corporation [1986] Ch 246 at 296G-H per Slade LJ.

Background facts

9. The key question on this appeal is whether, on his assumption of an undervalue, the deputy judge was wrong to reject the claim that the sale of the shares by PPC was in substance an unlawful distribution of assets. On PPC's case it was significant that, at the date of the sale, both PPC, the vendor, and Moorgarth, the purchaser, were under the control of the same holding company, Tradegro (UK) Limited (Tradegro). Further, the sale terms were negotiated by Mr Cornus Moore, who was a director of both the vendor and the purchaser companies and the right hand man of the chairman of Tradegro's ultimate parent company (Dr Christo Wiese).
10. At the date of the sale Tradegro owned 75.1% of the shares in PPC. The remaining 24.9% of the shares were held by Mr Charles Price. Mr Cornus Moore was the individual principally responsible for negotiating the sale of PPC's shares in YMS1 to Moorgarth (previously Foldfree). Tradegro owned all the shares in Moorgarth. As the vendor and the purchaser of the shares were under the same control the situation was no different, in principle, from that of a transfer of assets direct to a member of the company.
11. Legal proceedings followed on the change in the control of PPC that took place as a result of a Sale Agreement dated 3 October 2003. Tradegro agreed to sell its shareholding in PPC to a company wholly owned by its then fellow shareholder in PPC, Mr Charles Price, who negotiated with Mr Moore acting on behalf of Tradegro. Mr Price's company was Wigmore Street Investments Limited (WSIL, previously Real Estate Property Corporation). Mr Price indirectly became the owner of PPC. It was a term of that agreement that, prior to completion, Tradegro would procure the transfer to its subsidiary Moorgarth of the entire issued share capital in PPC's subsidiary YMS1. That transfer was effected on 20 October 2003.
12. There was no dispute before the deputy judge that Mr Moore genuinely believed that the price of the shares in YMS1 sold by PPC to Moorgarth was their market value. It was not alleged that there was any intention on his part to prefer Moorgarth or to commit a fraud on the creditors of PPC. He acted in the honest belief that the sale of the shares in YMS1 was a commercial transaction.
13. The deputy judge referred to the conflict of expert evidence on the value of the shares. His view was that, for the purposes of his analysis of the claim, it was more convenient

"….to proceed on the undetermined assumption that the sale price was based on an undervaluation of the YMS portfolio and was in consequence less than the market value of the shares of YMS-1."

14. It is common ground that, if his decision reached on the assumption of an undervalue was wrong in law, it will be necessary for the issues of valuation and possibly also of what Mr Moore ought to have known to be remitted for determination at another trial.

Judgment

15. Under the heading "Unlawful distribution of assets" the deputy judge considered together the claims against Mr Moore for breach of duty as a director and against Moorgarth for the return of shares transferred under an ultra vires transaction. In rejecting both heads of claim he said this-

"38. PPC contended that the disposal of the shares at an undervalue constituted an unlawful distribution of the assets of the company to a shareholder and was therefore ultra vires. This allegation formed the basis of a claim for breach of duty against Mr Moore, and a consequent claim against Moorgarth for the return of the shares or monetary relief.

39. PPC submitted that a transaction is not only illegal but ultra vires whenever the company has entered into a transaction with a shareholder which results in a transfer of value not covered by distributable profits, and regardless of the purpose of the transaction. This proposition was said to be vouched by the decision of Hoffmann J in Aveling Barford Ltd v. Perion Ltd [1989] BCLC 626.

40. PPC's submission is not supported, and indeed is positively belied, by Aveling Barford. In that case the plaintiff company sold a property at what was known to be an undervalue to a company controlled by an individual who also controlled the plaintiff company. The sale was approved by all the shareholders. That would not however validate the sale if the disposal of the shares constituted a prohibited distribution of the company's assets to a shareholder and was therefore ultra vires. Though the company undoubtedly had power under its memorandum to sell its assets, Hoffmann J held that the transaction was not a genuine exercise of that power, since "it was a sale at a gross undervalue for the purpose of enabling a profit to be realised by an entity controlled and put forward by its sole beneficial shareholder." Though the transaction was not a sham and was in law a sale "it was the fact that it was known and intended to be a sale at an undervalue which made it an unlawful distribution."

41. In the present case, however, Counsel for PPC expressly accepted that Mr Moore "subjectively knew and intended [the YMS transaction] to be a sale at market value", and indeed the contrary was never pleaded or suggested by him to Mr Moore in cross examination. He was therefore driven to argue that the words I have quoted from Hoffmann J's judgment were mere obiter. On the contrary, it is clear that they are not only a fundamental part of his reasoning, but the immediate basis of his decision. Even if they fell technically to be analysed as obiter, they not only represent the considered view of Hoffmann J but are to my mind entirely convincing.

42. Accordingly, I reject the claim against Mr Moore, and by extension Moorgarth, in so far as it is based on the contention that the transaction was ultra vires."

16. It was noted in the course of submissions to this court that the decision in Aveling Barford caused alarm in the company law world about its potential impact in casting doubt on the legality of intra-group transfers of assets at book value rather than by reference to market value: see Gower & Davies' Principles of Modern Company Law (8^th ed) at pages 291-292. Those concerns were explored in the Company Law Review and in the White Paper on Company Law Reform, which preceded the legislation (sections 845 and 846 of the Companies Act 2006) addressing those concerns. The new statutory provisions are irrelevant to this case and do not disturb the formulation of the underlying common law rule on distributions by Hoffmann J, or his reasoning.

PPC's submissions

17. It has never been contended that the sale of the YMS1 shares was ultra vires in the more conventional sense of being outside the express powers contained in PPC's Memorandum of Association. In this court Mr Matthew Collings QC appearing for PPC again made the decision of Hoffmann J in Aveling Barford the main plank of his argument. It was, he said, an instance of the common law rule that a company cannot, 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. An unauthorised return of capital to shareholders is unlawful. It is an ultra vires act incapable of validation by shareholder ratification.
18. Mr Collings submitted that Aveling Barford was authority for the proposition that that common law rule is applicable where a company has sold its corporate assets at a gross undervalue to a shareholder or, as in this case, at the behest of a shareholder in control of both the vendor and purchaser of the relevant shares.
19. Mr Collings put the case on two alternative bases. The more optimistic submission, not pursued with much vigour, was that the principle is one of strict liability. A reduction in the capital of the company was unlawful if in fact there was a failure to obtain full value for the sale of the asset whether the sale at an undervalue was effected deliberately or in ignorance, in bad faith or in good faith, for improper motive or for purportedly proper motive. This argument is plainly unsustainable; apart from any other considerations, it would mean that directors authorising a sale would always be at risk of a possible claim however reasonably they behaved.
20. The alternative and narrower submission was that Mr Moore ought to have known that the transaction was at an undervalue. His subjective belief that it was at market value was without basis. Objectively viewed, his belief was unreasonable and negligent. There was no basis on which the reduction in the price could be justified by reason of the consideration relied on, namely a purported release of PPC's non-existent indemnity liability. The transaction wore the dressing of a sale at market value, which it was not.
21. Mr Collings also insisted that the sale of the shares in YMS1 was made for a collateral purpose, namely to facilitate the sale of Tradegro's shareholding in PPC, and not for the proper purpose of benefiting and promoting the prosperity of PPC.
22. As back up for his submissions on the authorities Mr Collings also relied on the provisions in section 263 of the Companies Act 1985 which prohibit the making of a distribution to the members of the company "except out of profits available for the purpose." PPC's sale of its shares in YMS1 at an undervalue was, it was submitted, a "distribution" of a company's assets to a member and was caught by section 263 (1). It was not a distribution out of distributable profits or justified by reference to relevant accounts. It was unlawful and ultra vires under statute. It was conceded, however, that this submission added nothing to the common law position. Either the sale infringed both common law and the statutory provision or it infringed neither.

Discussion and conclusions

23. The common law rule devised for the protection of the creditors of a company is well settled: a distribution of a company's assets to a shareholder, except in accordance with specific statutory procedures, such as a winding up of the company, is a return of capital, which is unlawful and ultra vires the company.
24. Aveling Barford is a striking example of the application of the rule to a case in which a company had sold, at a gross undervalue, an important asset to another company under the control of the same person as controlled the vendor company. The property in question had been professionally valued at £650,000. Yet it was resolved that it would be sold by the company for £350,000, which the controlling shareholder knew was an undervalue. Though solvent, the vendor company did not have sufficient accumulated profits or distributable reserves to enable it to make distributions of assets.
25. Hoffmann J concluded that, although the transaction was in law a sale, in substance it was not a genuine exercise of the power of the vendor company to sell its property. The beneficial owner of the vendor company was obtaining what amounted to an unauthorised return of capital. That was ultra vires. It was not ratifiable by its shareholders.
26. Hoffmann J's explanation of the legal position is to be found in several short passages of his judgment.

"Whether or not the transaction is a distribution to shareholders does not depend exclusively on what the parties choose to call it. The court looks at the substance rather than the outward appearance. (page 631b-c)"

"So it seems to me in this case that looking at the matter objectively, the sale to Perion was not a genuine exercise of the company's power under its memorandum to sell its assets. It was a sale at a gross undervalue for the purpose of enabling a profit to be realised by an entity controlled and put forward by its sole beneficial shareholder. This was as much a dressed up distribution as the payment of excessive interest in Ridge Securities or excessive remuneration in Halt Garage." (page 632c-d)

"As for the transaction not being a sham, I accept that it was in law a sale. The false dressing it wore was that of a sale at arm's length or at market value. It was the fact that it was known and intended to be a sale at an undervalue which made it an unlawful distribution." (page 633c)

27. Like the deputy judge I am unable to accept Mr Collings's submission that the rule against distributions of capital to shareholders applies to this case simply because, through the Tradegro/Mr Moore connection, PPC's shares in YMS1 were sold to Moorgarth at an undervalue, as the deputy judge was prepared to assume was the case. Nor is it rendered unlawful because Mr Moore ought to have appreciated that the sale was at undervalue. The fact is that he did not. Hoffmann J plainly made it an essential part of the reasons for his decision that the sale of the company's asset was not a genuine sale, as it was known and intended to be a sale at an undervalue. That was what made it an unlawful distribution and ultra vires.
28. A similar approach had been adopted by Oliver J in the Halt Garage case of excessive remuneration cited by Hoffmann J. In that case remuneration had been paid to a person who was a director of and shareholder in the company but, for a number of years, had done no work for the company and was in fact unable to do so. When the company went into creditors' voluntary liquidation the liquidator claimed repayment of the sums paid to that director as having been ultra vires payments. The judge ordered re-payment on the ground that the payments could not "reasonably be described as a genuine reward for service" (page 1044e). The judge inferred from the objective evidence that the payments, though called "remuneration" and though not made with any intention to defraud anyone, were in substance "disguised gifts out of capital" (page 1044h). They were gratuitous distributions to a shareholder out of capital in recognition of the payee's co-proprietorship of the business. They were "dressed up as remuneration" and were not genuine reward for services rendered or to be rendered. (page 1042f)
29. Oliver J rejected, as the criteria of vires, such considerations as whether the payments were reasonable or whether they were for the benefit of the company. In my judgment the question whether they were for an improper purpose would likewise be irrelevant to the issue of vires. Those considerations were primarily management matters for the shareholders, not for the court. The correct test to be applied by the court on the issue of vires was to look to the true nature and substance of the payments and assess their genuineness (or otherwise) as payments of remuneration.
30. In this case the deputy judge noted that it had been accepted by PPC that the sale was entered into in the belief on the part of the director Mr Moore that the agreed price was at market value. In those circumstances there was no knowledge or intention that the shares should be disposed of at an undervalue. There was no reason to doubt the genuineness of the transaction as a commercial sale of the YMS1 shares. This was so, even though it appeared that the sale price was calculated on the basis of the value of the properties that was misunderstood by all concerned.
31. In my judgment, the deputy judge was right in holding that the sale of the YMS1 shares was not a disguised distribution of assets either in breach of the common law rule or in breach of section 263 or as being for a collateral purpose. It was an intra vires sale of shares for a proper purpose, even if, as was assumed, it was at an undervalue, and even if Mr Moore ought to have appreciated that fact. The authorities demonstrate that the issue is whether, on the facts as they were genuinely perceived by Mr Moore to be, and having regard to the nature and character of the payment, it could properly be characterised as something other than a gratuitous distribution to shareholders. In Aveling Barford and Re Halt Garage the payment (or at least part of it) could not. Here the payment could only properly and objectively be characterised as consideration for the sale of an asset without any element of gratuitous benefit.

Result

32. I would dismiss the appeal. The court was supplied with five lever arch files of documents. Detailed arguments were presented in writing and orally. But PPC has failed to show that the deputy judge was wrong in holding that the sale of PPC's shares in YMS1 was genuine, lawful and intra vires, even if it was at an undervalue.

Lord Justice Toulson:

33. I agree.

Lord Justice Elias:

34. I also agree.