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[1992] UKSSCSC CIS_379_1991 (03 February 1992)

R(IS) 8/92

Mr. D. G. Rice CIS/379/1991
3.2.92

Capital – shares in a company – whether claimant's position "analogous to that of ... partner in the business" – whether minority holding of shares subject to pre-emptive rights has a value

The claimant had been an executive director in his family's company. On resigning his office he received compensation of £50,000 plus a fixed-term loan of £50,000. He held shares in the company, some of which he sold using the proceeds to pay debts and reduce his mortgage. The remaining shares were subject to an agreement whereby the claimant undertook not to sell them, save in specific circumstances, nor pledge them as security. The company agreed to release him from restriction, after a specified date, in respect of 3,000 of the shares which could be used to secure a loan not exceeding £50,000.

The adjudication officer obtained a valuation of the shares from the company's accountants. Based on the net value of the company the shares were worth in excess of £196,000 but it was stated that the shares were not marketable because of a pre-emptive agreement. The adjudication officer nevertheless decided that the claimant had capital in excess of the prescribed limit of £8,000. On appeal the tribunal confirmed the adjudication officer's disallowance of benefit but on different grounds: they held that the loan of £50,000 received from the company was not capital and that the shares owned by the claimant had a nil value except for the 3,000 released from restriction, which were worth in excess of £8,000. The claimant appealed to the Commissioner.

Held that:

the question whether the claimant is "in a position analogous to that of a partner" for the purpose of reg. 51(4) of the IS (Gen) regs. 1987 is not defined and is a question of fact in each individual case. However, some broad principles apply:

(a) it is not enough to say that the criterion is whether or not the claimant participates in the business. A claimant may be a "partner" even when he is not undertaking activities in the course of the business (para. 8);

(b) partnerships are normally fairly small concerns involving a limited number of personnel (para. 9);

(c) for a claimant with shares in a limited company to be treated as being analogous to a "partner" he should be in a position to exercise significant influence over the way in which the business is conducted. A shareholder in a company who is not in such a position and who has no direct or indirect participation in the trading activities of the business is purely an investor (paras. 8 and 9);

a claimant's shares in a company, even those subject to a pre-emptive rights provision, do have a value and this should be calculated in accordance with reg. 49 of the IS(Gen) Regs. 1987. Any incumbrance can be deducted from the value of the shares. Any pre-emptive rights provisions fall to be considered under the principles laid down in IRC v. Crossman, IRC v. Mann (1937) AC 26. The value of the shares should be estimated at the price they would fetch if sold on the open market, subject to the Articles of Association, including the pre-emptive rights provision, and the terms of any resignation agreement (para. 11);

the fixed term loan of £50,000 was capital freely available to the claimant, notwithstanding that he was obliged to repay it after the stated term. R(SB) 14/81 affirmed; R(SB) 12/86 distinguished (para. 15).

DECISION OF THE SOCIAL SECURITY COMMISSIONER

My decision is that the decision of the social security appeal tribunal given on 23 April 1991 is erroneous in point of law and accordingly I set it aside. As it is expedient that I give the decision the tribunal should have given, I further decide that the claimant is not entitled to income support from 20 August 1990 because he has from that date been in possession of capital resources in excess of the statutory limit of £8,000.

This is an appeal by the claimant, brought with the leave of the tribunal chairman, against the decision of the social security appeal tribunal of 23 April 1991. The claimant asked for an oral hearing, a request which was acceded to. At that hearing the claimant was present, but unrepresented, whilst the adjudication officer appeared by Mr. S. Cooper of the Solicitor's Office of the Departments of Health and Social Security.

On 6 April 1989 the claimant, who had been an executive director in his family company, AHM and Son Limited, resigned his office on the terms and conditions set out in an agreement entered into between him and the company. He received compensation for loss of office in the sum of £50,000, and in addition obtained a loan of £50,000 for a fixed term of five years, subject to earlier repayment on the happening of certain events specified in the agreement. As a term of the agreement, he undertook not to sell the shares registered in his name, save under the circumstances there set out. Furthermore, he undertook not to pledge them as security. However, the company agreed to release him after 1 April 1990 from this restriction in respect of 3,000 of the shares, which could be used to secure a loan from the bank or similar institution for a sum not exceeding £50,000. Further, it was expressly provided that the restriction imposed under the agreement should not apply to 2,040 shares belonging to the claimant which were the subject of a current offer. In the event the claimant sold those shares for £61,200 which he employed, apparently, towards the following payments, namely corporation tax of £16,640, £20,000 in reduction of his mortgage, and £32,000 to the company for past share dealings.

On 16 October 1990 the Department wrote to AHM and Son Limited's accountants to ask the value of the shares, based on the net asset value of the company. On 1 November 1990 the accountants concerned confirmed that the total shares still held by the claimant were as follows:

11,287 ordinary shares of £1 each

150 3.9% preference shares of £1 each

4,986 3.25% redeemable preference shares of £1 each

The value of the shares based on the net asset value of the Company as at 31 December 1989 was:

Ordinary shares – £191,272.

3.9 % preference shares – approximately £50.

3.25 % redeemable preference shares, as they were redeemable at par, – £4,986.

The accountants went on to point out that these shares were not a marketable commodity, as, in the event of disposal, they had first to be offered to the existing shareholders on a pro rata basis, and anyway they could not be sold, by reason of the agreement that the claimant had entered into, until after the expiry of the time there stipulated.

On 20 August 1990 the claimant claimed unemployment benefit and income support. On 6 September 1990 the adjudication officer disallowed the claim to income support on the ground that the claimant's income exceeded his applicable amount. However, subsequently the adjudication officer decided that that decision was erroneous and he reviewed it. Nevertheless, he did not consider that the decision to disallow income support should be revised, because he was satisfied albeit on other grounds, that the claimant was not eligible for benefit. The claimant appealed against the refusal to revise. In his submissions to the tribunal, the adjudication officer contended that the claimant had capital in excess of the statutory maximum of £8,000, and as a result was not entitled to income support.

In the event, the tribunal confirmed the adjudication officer's refusal to revise the disallowance of benefit, but on different grounds from those relied upon by the adjudication officer. They took the view that the loan of £50,000 received by the claimant from the Company was not capital in his hands, but that although the shares owned by the claimant, other than the 3,000 released from restriction after 1 April 1990, had a nil value, the 3,000 shares were worth, after the expenses of disposal, in excess of £8,000 and for this reason the claimant was not entitled to benefit.

The claimant contended before me that his shares had no value. There was a pre-emptive rights clause in the Company's Articles of Association which applied to them, and, more to the point, he could not, in any event, sell them until four years after the date of his resignation. They were therefore unrealisable and should be given a nil value. However, before I consider this argument, there is another matter which has to be investigated. Did the claimant, as at the date of claim and thereafter, fall within regulation 51(4) of the Income Support (General) Regulations 1987 [SI 1987 No. 1967] . That particular provision reads as follows:

"51. (4) Where a claimant stands in relation to a company in a position analogous to that of the sole owner or partner in the business of that company, he shall be treated as if he were such sole owner or partner and in such a case-

(a) the value of his holding in that company shall, notwithstanding regulation 46 (calculation of capital) be disregarded; and

(b) he shall, subject to paragraph (5), be treated as possessing an amount of capital equal to the value or, as the case may be, his share of the value of the capital of that company and the foregoing provisions of this Chapter shall apply for the purposes of calculating that amount as if it were actual capital which he does possess."

Paragraph (5), to which paragraph (4) is made subject, reads as follows:

"51. (5) For so long as the claimant undertakes activities in the course of the business of the company, the amount which he is treated as possessing under paragraph (4) shall be disregarded."

Manifestly, the claimant was not the sole owner of the company, but was he "in a position analogous to that of partner in the business of that company?"

No guidance is given in the regulations as to what constitutes being in a position analogous to a partner and presumably it is a question of fact in each individual case. However, some broad principles must clearly apply. Manifestly, a shareholder in such a company as ICI could not on any footing be regarded as a "partner" in the business. He is purely an investor, with no direct or, in practice, indirect participation in its trading activities. But clearly it is not enough to say that the criterion is whether or not the person concerned participates in the business. For it is clear from paragraph (5) that the legislature contemplates that a claimant may be a "partner" even when he is not undertaking activities in the course of the business. Accordingly, participation is clearly not a pre-requisite of being a "partner".

Mr. Cooper gave, as an illustration of how the provision might apply, the case of a partnership which came to be incorporated. The interest of the partners would be reflected in their shareholding and in those circumstances they could properly be regarded as "partners" within paragraph (4). I think that is right, but, like him, I consider that the language of paragraph (4) extends more widely to encompass other situations. But there must be limitations on its scope. I consider that the word "partner" in itself is suggestive of some limitation. Normally, partnerships are fairly small concerns and involve a limited number of personnel. I am aware, of course, that in the case of the very largest firms of solicitors, and still more so those of accountants, the latter operating on an international scale, the number of partners can be remarkably large. However, these are rather special cases where the rules of the relevant professions preclude operating under a corporate guise. Partnerships are usually fairly small. The second limitation which would seem to me reasonable to impose is that the "partner" should be in a position to exercise some significant influence over the business. In a true partnership, a partner would expect to have some say in the way in which the business is conducted, particularly in view of his unlimited liability for business debts, and by analogy a claimant who is to be treated as a "partner" in a limited company should, in my judgment, also be in a position to exercise some significant influence. If he is not in a position to do so, then I consider that he could not reasonably be regarded as a "partner". Fortunately, in the present instance, I do not consider that there is any great difficulty. The claimant informed me that the Company had been incorporated in 1938 having been established by one of his ancestors in, I think he said, the 18th century, that he only had 10% of the total shares, and that the working directors had 60% - 70% of the share capital. He stated that he had no influence over them, I rather gather that relationships were not of the best. Accordingly, it would seem to me fairly clear that at the date of claim the claimant was not a "partner", nor has his status changed since.

If the claimant did not fall within paragraph (4), then his shares had to be valued as such as at the date of claim. The claimant contended that they had no value, first because of the pre-emptive rights provisions. I do not consider that there is any force in this contention. It is clear that the shares had to be valued in accordance with regulation 49 which provides as follows:

"49. Capital which a claimant possesses in the United Kingdom shall be calculated –

(a) . . . at its current market or surrender value, less

(i) where there would be expenses attributable to sale, 10 per cent; and

(ii) the amount of any incumbrance secured on it."

It will be noted that a claimant is entitled to deduct from the value of his shares "the amount of any incumbrance secured on it" In the present case, the claimant pledged his shares as security for the loan of £50,000 and accordingly they were incumbered. It follows that he was entitled to deduct from the value of the shares the amount of that incumbrance. It should be noted that this operates more favorably for the claimant than would be the case if he were caught by regulation 51(4). There is no similar provision enabling the sum secured to be deducted from the value of the Company's assets attributable to him. But how was the market value of the shares affected by the pre-emptive rights provision contained in the Company's Articles of Association?

This question was considered in the context of estate duty, where a similar provision required the relevant shares to be given a market value, by the House of Lords in IRC v. Crossman, IRC v. Mann [1937] AC 26. Their Lordships held that the value of the shares was to be estimated at the price which they would fetch if sold on the open market on the terms that the purchaser should be entitled to be registered and to be regarded as the holder of the shares, and should take and hold them subject to the Articles of Association, including the pre-emptive rights provision. I think the same principle should be applied here. Moreover, I see no reason why it should not be applied in relation to the further restriction imposed in this case by the terms of the resignation agreement. As far as that particular agreement is concerned, a prospective purchaser would be subject to a very limited restriction on his powers of disposal, in that, after the expiry of the four years, the restriction would have no effect. The greater restriction would be that flowing from the pre-emptive rights provision in the Articles of Association. Of course, irrespective of any pre-emptive rights provision, the value of a minority holding of shares will not normally be equal to the corresponding proportion of the company's underlying assets. It will depend upon a variety of factors including income yield, dividend cover, marketability, future prospects, and all the other numerous matters taken into account by the market in giving a value to shares.

The fallacy underlying the view of the tribunal that, owing to the restrictions of the agreement, the shares affected apart from the 3,000 had no value can, perhaps, be demonstrated by the following line of reasoning. Suppose the shares, in question without any restriction on their alienability, were worth £30 each. It would, I think, be open to the claimant, notwithstanding that he was prevented from directly selling the shares, to sell an option for say £20 a share, under which the purchaser would acquire the right to buy the shares, on the expiry of the period of restriction, for the sum of £1 each. Assuming that the shares remained the same in value at the time when the option became exercisable, the purchaser would have £9 profit, and meanwhile the seller would have made an immediate realisation of £20 per share (followed in due course by a further £1 a share). I apprehend the seller would have had to sell at a discount, but the point that I am making is that clearly the shares had a value.

Accordingly, the tribunal erred in point of law in saying that the shares had, as a general principle, to be given a nil valuation. However, the tribunal were prepared to give a valuation to the 3,000 shares which were available to the claimant to lodge as security for a loan. They do not explain how they arrived at a valuation or what it exactly was. They merely stated that these should be valued, after deduction of costs, at a sum well in excess of £8,000. But, apart from not explaining how they reached this conclusion, they failed to deduct the value of the loan secured on these shares. Accordingly, on that point also they erred in point of law.

As regards the £50,000 loan, which was secured against the shares, the tribunal decided that this was not a capital asset. They said that, as the claimant was obliged to repay this sum in 1993, he was in no position to spend any of it. It was therefore not a freely available capital asset. They appear to have reached this somewhat surprising conclusion on the basis of R(SB) 12/86.

The £50,000 loan was represented by various deposits in building societies and other investments. It was in fact freely available to the claimant. He could do with it as he wished. There was, of course, an obligation to make repayment at the due date. But debts are not, unless specifically secured on the relevant property, deductible. This was well established in respect of loans under the supplementary benefit legislation (see for example para. 7 of R(SB) 14/81), and clearly, in view of the corresponding enactment under the income support legislation the position continues the same. The decision in R(SB) 12/86 has no application. That decision was concerned with a case where there was a trust imposed on the application of the loan. In the present instance, the claimant was free to use the loan in whatever way he wished. Manifestly, the £50,000 did constitute capital, and in reaching the contrary conclusion, the tribunal erred in point of law on that ground also.

It follows from what has been said above that I must set aside the tribunal's decision as being erroneous. However, it is unnecessary for me to remit the matter to a new tribunal for rehearing. I can conveniently substitute my own decision. Although the shares clearly have a value, it is unnecessary for me to go into the matter and to determine what it is. I can conveniently dispose of this case on the basis that the claimant had from 20 August 1990 and, as he informs me, still has, £50,000 at his disposal. That sum is in excess of the statutory limit of £8,000, and as a result the claimant has from 20 August 1990 been disentitled to benefit. Accordingly, my decision is as set out in paragraph 1.

Before leaving this matter I should say that the claimant, in his address to me, complained of lack of assistance and advice from the local office, and maintained that had he received proper assistance and advice he might have adopted a different course of conduct. Complaints of this nature do not fall within my jurisdiction. They are for the Secretary of State.

My decision is as set out in paragraph 1.

Date: 3 February 1992 (signed) Mr. D. G. Rice

Commissioner