This week:
- The Government announces proposed legislation for audit reform and corporate governance in the King's Speech
- FTSE Russell announces the composition of its UK Index Series (including the FTSE 100) following the UK's listing regime reforms
- The London Stock Exchange announces changes to its Admission and Disclosure Standards and the closure of the High Growth Segment
- The Financial Conduct Authority provides an update on its review of the sponsor regime
- A shareholders' agreement was novated by the parties' conduct, despite a clause prohibiting dealing with rights under it
Audit and governance reforms announced in King's Speech
The Government has announced, in the first King's Speech since the General Election, that it intends to bring forward legislation to introduce audit and corporate governance reform.
Dubbed the Audit Reform and Corporate Governance Bill, the new legislation would finally replace the Financial Reporting Council (FRC) with the new Audit, Reporting and Governance Authority (ARGA), a change confirmed years ago but which remains unimplemented.
The Bill would also make other changes, including:
- expanding the range of entities that qualify as public interest entities (PIEs) (which are subject to greater regulation and oversight) whilst, at the same time, removing unnecessary rules for smaller PIEs;
- introducing powers to investigate and sanction company directors for serious failures in relation to financial reporting and audit responsibilities; and
- creating a regime to oversee the audit market and protect against conflicts of interest at audit firms.
Access the background notes to the King's Speech 2024 (opens PDF)
FTSE Russell confirms new index series following listing regime changes
FTSE Russell, the business responsible for maintaining the FTSE indices, has confirmed how the indices will be composed once the changes to the UK's listing regime come into effect on 29 July 2024.
Currently, to be eligible for inclusion within the FTSE UK Index Series (including the FTSE 100, FTSE 250 and FTSE All-Share), a company must have a "premium listing". However, under the reforms, the current premium and standard segments will be collapsed into a single "equity shares (commercial companies)" (ESCC) category. Premium-listed companies will be mapped automatically to the ESCC.
The announcement confirms that the ESCC category will become the eligible universe for the FTSE UK Index Series, replacing the premium segment.
Separately, closed-ended investment funds with a premium listing will map automatically to a new closed-ended investment fund category and retain index eligibility.
FTSE Russell states that impact of the change is likely to be small in the short term, with no immediate impact on the UK Index Series' composition.
LSE updates admission standards and closes High Growth Segment
The London Stock Exchange Group has published proposed changes to its Admission and Disclosure Standards, which apply to companies admitted to (or applying for admission to) its Main Market for securities.
The proposed changes are designed to accommodate the reforms to the UK's securities listing regime reflected in revised Listing Rules published by the Financial Conduct Authority last week. In particular, the proposed changes reflect the abolition of the previous "premium" and "standard" listing segments.
In addition, in light of the changes to the listing regime, the Exchange now regards its High Growth Segment (HGS) as redundant and has decided to close it. (This move is not entirely unsurprising, as there are currently no companies admitted to the HGS and none have been admitted for over a year.)
The amendments to the Admission and Disclosure Standards will become effective on 29 July 2024, the same date on which the listing regime changes will come into force.
FCA provides update on sponsor regime review
The Financial Conduct Authority has published Primary Market Bulletin 50, in which it provides an update on its fundamental review of the sponsor regime.
Companies with a premium listing are required to retain a sponsor when applying for listing and while listed. Under changes to the listing regime published last week, companies with a listing in the "equity securities (commercial companies)" (ESCC) category, which replaces the premium listing category, will continue to require a sponsor, albeit for a narrower range of matters.
The bulletin provides specific updates on sponsor specialist due diligence and record-keeping, as well as supervisory reviews of sponsor services.
Read FCA Primary Market Bulletin 50 on the review of the sponsor regime
Shareholders' agreement was novated informally to new shareholder
The High Court has held that a shareholders' agreement was novated from an outgoing shareholder to a new incoming shareholder, despite there being no written novation agreement and the fact that the shareholders' agreement contained a clause prohibiting parties from "dealing" with their rights under it.
Magee and ors v Crocker and anor [2024] EWHC 1723 (Ch) concerned a company set up to develop a golf course on farming land.
The parties entered into a shareholders' agreement relating to the management and governance of the company. That agreement stated that no party was permitted to "assign, grant any encumbrance over or sub-contract or deal in any way with any of its rights" under the shareholders' agreement (the no-dealing clause).
In due course, one of the shareholders decided to transfer its shares in the company to a trust. The other parties acquiesced in the transfer and the company registered it in its statutory books.
In connection with this, the outgoing shareholder also executed a deed of assignment in favour of the incoming trustee, which purported to "[assign] all rights and obligations attaching to [the shares] pursuant to the [shareholders' agreement]" for a sum of money.
A question arose over whether the assignment was valid, given the no-dealing clause in the shareholders' agreement. The incoming shareholder argued that a novation had in fact taken place, notwithstanding the use of a "deed of assignment" and the existence of the no-dealing clause. (See box "What is a novation?" below for more information.)
What is a novation?
Suppose that two parties (X and Y) enter into a contract.
Circumstances may arise in which X may wish to transfer that contract to someone else (Z). This might happen, for example, because X is selling their business and assets to another person, or because X's group of companies is undertaking group restructuring.
One way to transfer contractual rights is by making an assignment. Under this process, X and Z enter into an assignment agreement, then one of them serves a written notice on Y notifying them that X has assigned the contract to Z.
A theoretical advantage of assignment is that, as a matter of law, it does not require the consent of the original counterparty (in this case, Y), although sophisticated commercial contracts normally contain provisions prohibiting an assignment without the counterparty's written consent.
One drawback of an assignment is that, under English law, a person can assign their rights under a contract, but not their obligations. So, X would remain liable under the contract even after they have assigned it to Z and stopped performing it. The rationale for this is that X's identity and financial standing may be important to Y, and so Y is entitled to assume they will be dealing with X throughout the lifetime of the contract.
The other way to transfer a contract is novation. Under this process, X, Y and Z collectively agree that, from a specific point in time, the contract will continue with Z performing X's obligations and enjoying X's rights under the contract.
The key advantage of a novation is that a person can transfer both their rights and their obligations under a contract. This allows X to draw a "line in the sand" and gain a "clean break" from the contract.
However, unlike an assignment, a novation will always require the counterparty's consent. For this reason, novation is usually restricted to contracts that are more material to a business (generally due to their value or their strategic significance).
Technically, a novation involves terminating the old contract between X and Y and creating a brand-new contract between Z and Y. Normally, this is done through a novation agreement that sets out exactly what liabilities Z is assuming, including (in particular) whether Z is taking on X's obligations only going forward or whether Z will also be taking on X's historic liabilities under the contract. The novation agreement may also provide a mechanism for X and Z to cross-indemnify each other.
However, the courts have also found that it is possible for a novation to take place by conduct if a novation is a necessary explanation for the parties' subsequent behaviour.
The court found that the parties had novated the shareholders' agreement, so that it now took effect between the remaining shareholders and the incoming shareholder. In reaching this decision, the court made the following comments.
- The no-dealing clause did not prevent a novation, because a novation did not involve any dealing with existing rights under the shareholders' agreement. Rather, it involved terminating the existing shareholders' agreement and replacing it with a brand-new one.
- Even if a novation did involve dealing with existing rights, the no-dealing clause did not apply, because the words "deal in any way" had to be read ejusdem generis with the words "assign", "grant encumbrance over" and "sub-contract" (see box "What is the ejusdem generis rule?" for more information). Those words all suggested a bilateral transaction involving only the outgoing and incoming shareholders (such as an assignment). However, in this case, all parties had consented to the transfer and so it more closely resembled a novation.
- The fact that the outgoing and incoming shareholders had entered into a formal "deed of assignment" did not affect the position. The court looked at the substance of the transaction over its form, finding that all parties had acted as if a novation had occurred.
What is the ejusdem generis rule?
One of the principal roles of the court is to rule on disputes over the meaning of a contract. To do this, the court embarks on an exercise of contractual interpretation.
There are various tools a court has at its disposal when ascertaining the meaning of a contract. This includes applying principles that are available to identify the meaning of legislation.
One of these principles is the ejusdem generis (or eiusdem generis) rule, from the Latin meaning "of the same kind".
Broadly speaking, this rule states that, where a contract contains general wording preceded by a list of items, the court will interpret the general wording in the context of the specific, listed items. In other words, it will assume that the general wording includes only items of the same kind as those listed.
The rule is easier to explain by example. Imagine the following list:
"cars, trucks, buses, coaches, taxis and other vehicles"
The words "other vehicles" are generic and could, in theory, describe any form of transport that gets a person from A to B.
However, applying the ejusdem generis rule, a court might decide that the words "other vehicles" need to be understood in the context of the words "cars, trucks, buses, coaches [and] taxis". So, for example, it might decide that the words "other vehicles" only include vehicles that travel solely or mainly on land. They would not, therefore, include aeroplanes, helicopters, ships or hovercraft.
Indeed, a court might take an even narrower view, finding that the words refer not only to land-based vehicles, but only to land-based vehicles that are powered by an engine. So, for example, it might decide that the words do not include pedal bicycles or kick scooters.
However, it is not always straightforward to decide what the category is. For example, in the list above, would the words "other vehicles" include electric bikes and motorised scooters? If not, where is the line drawn? What about mopeds, or motorcycles with a small (e.g. 50cc) engine? Or does the list refer to any vehicle with more than two wheels, so that all bikes and motorcycles are excluded?
A court will therefore also need to take into account the context in which the clause appears. Indeed, both text and context are key components in any exercise in interpretation and now form equal elements in orthodox contractual construction.
Contract parties can try to deal with the ejusdem generis rule in the contract itself. For example, it is not uncommon to see language designed to extend the meaning of generic words as broadly as possible (e.g. "or other vehicles of any kind whatsoever").
In addition, sophisticated contracts often explicitly disapply the ejusdem generis rule by including wording in the interpretation clause such as: "The meaning of general words is not limited by any specific words preceding them."
However, in either case, whether this has any effect will, again, depend on the surrounding text and context of the contract.
In many respects, the decision is similar to that in Musst Holdings Ltd v Astra Asset Management Ltd [2023] EWCA Civ 128, which involved the novation by conduct of an introduction agreement. You can read more about Musst Holdings v Astra Asset Management in our separate in-depth piece, which also contains useful tips to bear in mind when considering an assignment or novation of a contract.
The decision is the latest in a line of recent cases revolving around the interpretation of contracts in a corporate context. For more, you can:
- read our in-depth piece on the interpretation of a compulsory transfer mechanism in a company's articles; and
- read our in-depth piece on the interpretation of an adjective before a list in a broker's engagement letter.
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.