Scottish Court of Session Decisions

Petitioner: Sellar, Q.C.; DLA Piper Scotland LLP

7 December 2011

[1] This unopposed application by Sportech plc ("the company") for an order cancelling its share premium account, which I have granted, raised questions as to the correct approach to the protection of creditors where the cancellation would give rise to distributable reserves. The principal question was whether I should exercise the power of the court under section 645(3) of the Companies Act 2006 to disapply section 646 of that Act, which entitles certain creditors to object to the cancellation, where the company did not propose to give an undertaking in conventional terms for the protection of its existing creditors. A question also arose as to how the court should approach section 646(1)(b) of the Companies Act 2006. That subsection provides that before a creditor of a company can object to a reduction of capital he must show that

"there is a real likelihood that the reduction would result in the company being unable to discharge his debt or claim when it fell due."

[2] I am grateful to Mr John B Stirling WS, the court reporter, for his careful report which flagged up the principal issue and to counsel for his submissions which persuaded me to make the order.

Background

[3] The company is a holding company of a group of companies which carry on betting and leisure businesses in the United Kingdom and elsewhere. As a result of certain share transactions the company had a credit balance of £20,722,595 on its share premium account. When the company gave notice of the special resolution to cancel its share premium account and when its Annual General Meeting ("AGM") was held on 12 May 2011, there was a deficit on the company's profit and loss account of £4,158,100 and deficits on its share option reserve and financial instrument reserve giving rise in aggregate to a deficit of £6,097,009. Shortly after the AGM, and as a result of revised funding arrangements for the group by its bankers, substantial dividends were paid to the company by its subsidiaries. Those dividends removed the deficits and produced a positive balance of £11,898,000 on the company's profit and loss account.

[4] Accordingly, on cancellation of the share premium account a further £20,722,595 would come to be treated for the purposes of Part 23 of the 2006 Act as realised profit and thus part of the company's distributable profits unless the court ordered otherwise: Article 3(3) of the Companies (Reduction of Share Capital) Order 2008 (SI 2008/1915) and section 648(1) of the 2006 Act. Although the company had no present intention to pay out this deemed realised profit, it was not disputed that the creation of that realised profit amounted to "payment to a shareholder of any paid-up share capital" under section 645(2)(b) of the 2006 Act because it would give the company the ability to make such a payment: Lawrie & Symington Ltd, Petitioners 1969 SLT 221.

[5] I was satisfied that the change in circumstances since the dates of the notice and the AGM would not have affected the way in which a reasonable shareholder would have voted: Re MB Group [1989] BCLC 672; Re Allied Domecq plc [2000] 1 BCLC 134. The expressed purpose of the cancellation was to remove the deficit on the profit and loss account so as to create distributable reserves to allow the company to pay dividends in future. While the company had larger distributable reserves than were then envisaged, the purpose of the exercise remained the same in its essentials. I also agreed with the reporter's conclusion that the infelicity in the wording of the special resolution and the inadvertent failure to give formal notice of the AGM to the company's auditors and one director did not invalidate the procedure: section 313 of the 2006 Act. Accordingly, while the drafting of the resolution and the procedural errors were below the standard which the court would ordinarily expect in such an application, I agreed with the reporter that the special resolution had been validly passed and the relevant procedure had been complied with. I also accepted that the cancellation was for a discernible commercial purpose and it was fair to the company's shareholders. The other requirement, namely whether the interests of creditors were adequately safeguarded, was the principal concern.

[6] Under section 645(2) of the 2006 Act, as the proposed cancellation fell to be treated as involving "the payment to a shareholder of ... paid up share capital", section 646, which I discuss below, applied unless the court directed otherwise.

The protection of creditors

[6] Parliament has protected creditors by requiring their consent to a reduction of capital, including the cancellation of a share premium account. Unless the claims of existing creditors who might be affected by the reduction were secured, or the company had already obtained their consent, or the company otherwise satisfied the court that it might dispense with that consent, the court had to compile a list of those creditors so that they were notified and given an opportunity to object. See section 67(2) of the Companies Act 1948 and section 136(3)-(5) of the Companies Act 1985.

[7] In practice, as Lord Glennie recorded in his opinion in Royal Scottish Assurance plc, Petitioner 2011 SLT 264 (at para [8]), it has since 1949 been the invariable practice of this court and the Companies Court in London to disapply the requirement for a list of creditors on obtaining satisfactory assurances that their interests have been protected. That assurance has come in a number of forms. First, for some years the court has accepted an undertaking by the company that it will not make any distribution until the creditors whose claims are outstanding when the proposed cancellation becomes effective have either consented or been paid off. See, for example, Quayle Munro Ltd, Petitioners 1992 SC 24. Secondly, the court has dispensed with the requirement if a company has shown that it has a sufficient margin of solvency to meet the claims of non-consenting creditors. Normally, the court considered whether the company had cash and readily realisable assets, such as listed securities and debtors after due allowance for bad debts, which could provide for both the claims of non-consenting creditors and the amount which the company would be allowed to return to its shareholders, together with a reasonable margin of safety: Anderson Brown Ltd 1965 SC 81; Martin Currie Ltd, Petitioners 2008 SLT 57. But it did not adopt a formulaic approach. Rather it looked at the commercial circumstances of the particular company in deciding what amounted to sufficient protection. Thus, in Martin Currie Ltd, Petitioners (above) Lord Drummond Young considered that the book value of the private companies which were the subsidiaries of the petitioners could be taken into account in assessing what was available to protect its existing creditors. Other means of providing the needed assurance have included the provision of third party guarantees, the appropriation of cash in an account dedicated specifically to the payment of those creditors, and the subordination of the claims of consenting creditors to those of non-consenting creditors: Royal Scottish Assurance plc, Petitioner (above) Lord Glennie at para [8].

[8] The critical question which the court has had to address when deciding whether to dispense with the settlement of a list of creditors has been:

"whether there is any significant risk of prejudice to the company's existing creditors, in the sense that those creditors may not have their debts paid in ordinary course."

(Martin Currie Ltd, Petitioners (above), Lord Drummond Young at para [10])

In my opinion that question remains relevant under the current provisions in the 2006 Act, although the way in which the court approaches the question has been altered by statutory innovation as set out below.

[9] The Company Law Review, which between 1998 and 2001 sought to overhaul the company law of the United Kingdom, initially favoured simplifying the means by which companies could reduce their capital. The Steering Group proposed to dispense with the requirement of court approval which has been part of our statutory company law since 1867. It suggested that a company should be able to reduce its share capital by passing a special resolution and by its directors' making a declaration of solvency. This regime was applied to private companies limited by shares in sections 642-644 of the 2006 Act, which require the directors of the company to make a solvency statement not more than fifteen days before the resolution is passed and the subsequent registration of both the resolution and the solvency statement. But that liberalisation was not open in relation to public companies because the EU Second Company Law Directive (Directive 77/91/EEC) gave creditors of such companies a right to apply to the court if the security for their claims or other safeguards were not adequate. Thus sections 645-653 of the 2006 Act have preserved the confirmation by the court of reductions of capital.

[10] Section 646 of the 2006 Act was amended by regulation 3 of the Companies (Share Capital and Acquisition by Company of its Own Shares) Regulations 2009 (SI 2009/2022), which introduced section 646(1)(b), to which I have referred in paragraph [1] above. The amendment implemented a change to the Second Company Law Directive made by Article 1(9) of Directive 2006/68/EC. It has the effect that a creditor who objects to a reduction in a company's capital must demonstrate that his claim is at risk and that the company has not provided adequate safeguards. Thus section 646(1) now provides:

"Where this section applies ..., every creditor of the company who -

(a) at the date fixed by the court is entitled to any debt or claim that, if that date were the commencement of the winding up of the company would be admissible in proof against the company, and

(b) can show that there is a real likelihood that the reduction would result in the company being unable to discharge his debt or claim when it fell due,

is entitled to object to the reduction of capital."

[11] This provision therefore requires the court, when faced with an application by a company to disapply section 646, to consider first whether a creditor could demonstrate such a real likelihood. In Liberty International plc [2010] 2 BCLC 665, Norris J gave guidance on the "real likelihood" test. He suggested that one should not put a gloss on the statutory words and made three points. First, he suggested that the assessment should be grounded in the facts as they are known and should not be speculative. Secondly, he suggested that the assessment involved looking forward for a period in relation to which it was sensible to make predictions. And thirdly, he suggested that the creditor did not have to prove that a future event would happen; the court had to evaluate the chance of the occurrence of the inability to discharge the debt because of the return of capital. He stated (at para 21 of his judgment):

"[the section] describes the chance as 'real likelihood', thereby requiring the objecting creditor to go some way up the probability scale, beyond the merely possible, but short of the probable. That is the 'degree of persuasion' (as it was put by Hoffmann J in re Harris Simons Construction Ltd [1989] BCLC 202 at 204F to H) for which I have looked in assessing the evidence."

Norris J emphasised in para 17 of his judgment that he was describing the approach which he had adopted in that case and was not seeking to prescribe a course for others to adopt. Nonetheless, his three points appear to me to be correct. I consider that it is important that the courts of the various jurisdictions of the United Kingdom should adopt a similar interpretation of a UK statute and agree with Lord Glennie in Royal Scottish Assurance plc, Petitioner (above) that Norris J's guidance is helpful. I also agree with Lord Glennie in his emphasis (at p. 268 F-H of his opinion) that the creditor must show the real likelihood of a causal link between the reduction of capital and the company's inability to discharge his debt. Strictly, it is the return of capital to shareholders rather than the reduction itself which would be the cause, but the emphasis on the causative connection is the important point.

[12] In Royal Scottish Assurance plc, Petitioner (above) at para [11] Lord Glennie stated that the court was required to form a view as to whether there was any "realistic possibility" that any creditors of the company would be able to show such a real likelihood. In so doing he was not, in my view, seeking to dilute the test which the creditor must meet but was alluding to the fact that section 646(1) imposed on the creditor the burden of showing the "real likelihood". I do not construe the phrase "realistic possibility" as involving an exercise like that in fresh claims cases under Rule 353 of the Immigration Rules in which the court has to assess the possibility of an applicant persuading another person of his case. That in my view would be an unnecessary complication for which the statutory provision does not call. In practice it falls to the court, when deciding whether to disapply section 646 to form its own view on the "real likelihood", so far as can reasonably be foreseen, that capital would be returned to shareholders and that that return of capital would cause a company to be unable to discharge the creditor's claim. The court will expect the company to provide it with sufficient financial and other information to enable it to reach an informed view.

[13] One of the methods by which the court can reach an informed view is an assessment of the company's likely future cash flow solvency. This was the approach of Norris J in Liberty International plc (above) and Mr Sellar informed me that it is an approach which is frequently adopted in the Companies Court in London. He also informed me that Norris J wrote the judgment to give guidance to the registrars in that court. Again I think that it is important that there is a consistent approach to a United Kingdom statute

[14] In my view it is open to the court, when deciding whether to disapply section 646, to assess the likely future cash flow solvency of a company over a foreseeable period if sufficient information is provided to allow it to do so. In each case the court must look to the particular circumstances of a company and decide what amounts to an adequate safeguard of the interests of creditors: Anderson Brown Ltd (above); In re Lucania Temperance Billiard Halls (London) Ltd [1966] 1 Ch 98. Thus there will be cases in which it may choose, as in the past, to look to the company's cash and readily realisable assets for that safeguard. The test may be a useful one, for example, when the court is considering applications by investment trusts or similar companies.

[15] In this case I was satisfied that the company had provided sufficient information about its future cash flow to enable me to conclude that there was not a "real likelihood" of its making a return of capital which would prejudice the creditors who have not given their consent.

[16] The following circumstances are relevant. First, the company's accounts for the year to 31 December 2010 and the unaudited interim results for the six months to 30 June 2011 show that the group has been using cash generated by its businesses to reduce its liabilities. In the interim statement the directors stated:

"Continuing the policy of recent years, no dividend is proposed, as the Board believes that the Group's significant cash generation should be used to reduce debt as well as undertake selective investment."

That echoed a similar declaration in the chairman's statement in the accounts to 31 December 2010. Secondly, the company's cash flow projections as at 30 September 2011, which its finance director had approved, showed the continued reduction of bank debt, its partial replacement by inter-company loans and the continued payment of creditors in the context of a positive cash flow in the period to 30 September 2012. Thirdly, the company produced with its application the forecasts of four broking analysts which were consistent with the company's cash flow projections and showed the group producing a profit and reducing its bank debt in the year to 30 September 2012.

[17] Fourthly, the group's bankers, Bank of Scotland plc, which at 30 September 2011 were owed about £65.5 million in loans and £5.5 million by way of overdraft, have consented to the cancellation of the share premium account. Fifthly, the group companies which at 30 September 2011 were creditors of the company in about £8.4 million, have consented to the cancellation and subordinated their rights to those of non-consenting creditors. Sixthly, Scientific Games Corporation, which is entitled to receive a deferred consideration of $10,0000 on 30 September 2013 and may have a claim for a contingent consideration of either $5 million or $8 million on 15 February 2013, has consented to the cancellation and as a shareholder in the company voted in its favour.

[18] Seventhly, as at 1 December 2011 the creditors of the company, who were due payment within twelve months and whose consent had not been obtained, totalled £471,772 . This is a small proportion of the total creditors of the company with debts greater than £300, who at 1 December 2011 amounted to £79,760,000. The company also has a lease with ten years to run at annual rental of £144,000 which it has paid on time. The reporter accepted evidence from the company that, if it ceased to rent the property, the landlord would be likely to find a substitute tenant on no less advantageous terms within nine months. Eighthly, the company made a profit after taxation of £2.3 million in the six months to 30 June 2011. Ninthly, Mr Sellar submitted that there had been no material change in the overall economic or regulatory environment in which the company operated so that its projections were supported by its published accounts to 31 December 2010 and 30 June 2011.

[19] Finally, while the company has to renegotiate its term loans with Bank of Scotland plc in September 2013 or replace those loans, I see no reason to think that that bank will seek to withdraw its facilities if the company is generating cash and reducing its borrowings in accordance with its predictions. Where the bulk of the company's assets rested in the value attributed to its subsidiaries, it would be surprising if a lender were to put its lending at risk by undermining the group's business as a going concern. Nor, having regard to the company's public statements of its policy, do I see any "real likelihood" that the company would return capital to its members by paying dividends before it had renewed or re-financed its borrowings.

[20] I therefore concluded that a non-consenting creditor would not establish a "real likelihood" that the cancellation of the share premium account would result in the company being unable to discharge his debt when it fell due.

Conclusion

[21] For those reasons I was satisfied that I could properly make the order disapplying section 646 of the 2006 Act and confirming the cancellation of the company's share premium account without requiring it to give an undertaking as the reporter had suggested. I therefore made that order.