United Kingdom: Are Your Pre-Emption Rights On A Share Transfer Water Tight?

Last Updated: 30 April 2012
Article by Janice Wall

Do you have a "change of control" clause in your shareholders' agreement?  Are your pre-emption rights on transfer of shares comprehensively drafted?  If not the High Court case of McKillen v Misland (Cyprus) Investments Limited1  involving the back-door takeover by the Barclay brothers of Coroin Limited, the entity that owns the hotels Claridge's, the Connaught and the Berkeley should be a wake-up call for a review of your joint venture / shareholders' agreement and articles of association.

The Barclay brothers obtained control of Coroin Limited not by acquiring shares directly in Coroin Limited which would have been in breach of the pre-emption provisions on a share transfer in that company's articles of association and shareholders' agreement but by acquiring ownership of shares in Misland (Cyprus) Investments Limited, a shareholder in Coroin Limited. Mr J David Richards held that this was not in breach of the terms of those particular pre-emption rights. 

The judge made it clear in his judgment that a principle applicable to pre-emption articles is that as the right to deal freely with a share is an important attribute of ownership and prima facie right of a shareholder, the existence and extent of any restriction on transfer, such as pre-emption rights, must be clearly stated:

"Commonly used phrases in pre-emption provisions have distinct legal meanings and superficial small variations can have significant legal effects. This is relevant consideration when construing pre-emption provisions, particularly when as in this case they are complex and have been professionally drafted, using and adapting well known standard provisions."

The case makes it clear that pre-emption right provisions must expressly contain:

  1. restrictions on transfer of shares to prevent legal title being transferred; and
  2. restrictions on transferring or creating any interest therein to prevent beneficial interests being transferred outside the pre-emption provisions.

In addition, if the pre-emption provisions only restrict the above they do not prevent the sale of the shares in a shareholder itself that holds such shares in the joint venture company (JvCo).  Such a sale involves no change in the shareholder's legal and beneficial ownership of the underlying shares in the JvCo nor evidences a desire to transfer those shares or any interest in them. "Any interest therein" does not include indirect interests such as those it could be said arose by ownership of shares in the shareholder who held the underlying shares in the JvCo.

From the terms of the relevant shareholders' agreement it was clear that the JvCo was a vehicle for a venture between a restricted number of shareholders who had personal rights to appoint directors. The pre-emption provision was supposed to preserve the personal nature of the venture.  However, the lack of an express change of control provision allowing the pre-emption provisions to apply on the change of control of a shareholder in the JvCo meant this intention was not met leading to a rather unsatisfactory outcome for Mr McKillen. If you don't suddenly want to find yourself in partnership with a stranger make sure you have comprehensive pre-emption rights on transfers of shares, interests in shares, declarations of trusts, transfer of voting rights and change of control of the shareholder you went into business with originally.

The judge further stated that articles of association have a special status as a "statutory contract" adopted pursuant to the Companies Act, requiring public registration and being capable of amendment by special resolution. By reason of these provisions, the court has no jurisdiction to order rectification of articles or set them aside on grounds of misrepresentation. He also held that extrinsic evidence is not admissible in the construction of articles. This is because the articles govern relations between the company and its members and between the members. Members are a fluctuating body of persons. Persons become members on the basis of registered articles and without in most cases any knowledge of the circumstances existing when the articles were adopted or subsequently amended perhaps on many occasions.

Footnote

1. McKillen v Misland (Cyprus) Investments Limited [2012] EWHC 129 (Ch) is available at http://www.bailii.org/ew/cases/EWHC/Ch/2012/129.html.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Authors
Janice Wall
 
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