In this update: New restrictions on investing in Russia come into effect, the Government publishes new market guidance on aspects of the UK’s national security screening regime, former shareholders in a company were unable to claim against a co-investor to recover “reflective loss”, the EU courts permit the investigation of a merger where the target generates no revenue in the EU and a few other items.
New restrictions on investing in Russia come into effect
New sectoral sanctions have come into force that effectively prohibit a person from investing in assets or ventures in Russia.
Under amendments introduced by Russia (Sanctions) (EU Exit) (Amendment) (No. 12) Regulations 2022, it is now a criminal offence for a person to do any of the following things, either knowingly or if the person has reasonable cause to suspect they are doing so.
- Directly acquiring an ownership interest in land located in Russia.
- Indirectly acquiring an ownership interest in land located in Russia (but only if the purpose of doing so is to make funds or economic resources available to a person connected with Russia or for the benefit of a person connected with Russia).
- Directly acquiring an ownership interest in or control over a legal entity connected with Russia.
- Indirectly acquiring an ownership interest in or control over a legal entity connected with Russia (but only if the purpose of doing so is to make funds or economic resources available to a person connected with Russia or for the benefit of a person connected with Russia).
- Directly or indirectly acquiring an ownership interest or control in or over a legal entity that is not connected with Russia but which has a place of business in Russia (but only if the purpose of doing so is to make funds or economic resources available to a person connected with Russia or for the benefit of a person connected with Russia).
- Directly or indirectly establishing a joint venture with a person connected with Russia.
- Opening a representative office or establishing a branch or subsidiary in Russia.
- Providing investment services in relation to any of the activities described above.
The new restriction does not apply to activities carried out to satisfy a contractual obligation entered into before 19 July 2022.
The new restriction also does not apply (broadly speaking) to:
- dealing in certain types of publicly traded securities that were issued by a legal entity that is connected with Russia, or is owned by someone connected with Russia, and which were admitted to certain types of securities exchange before 19 July 2022; or
- dealing in certain types of securities that were issued by a legal entity that is not connected with Russia but which has a place of business in Russia.
New market guidance on UK’s national security screening regime published
The Government has published new market guidance notes on the UK’s national security screening regime (contained in the National Security and Investment Act 2021).
The topics in the guidance are based on analysis of notifications received under the regime and feedback from stakeholders on their experience of the system.
The Government has said that most interest has focused on the mandatory notification system. The first set of market guidance notes therefore concentrates on whether commonly-raised scenarios require mandatory notification.
Interesting points coming out of the market guidance notes include the following.
- Before submitting a notification to the Investment Security Unit (ISU), notifiers should read the GOV.UK guidance, structure their responses clearly, include all relevant information, and include the appropriate declarations and sign them correctly.
- Notifiers should select the “trigger events” that apply to the acquisition. It is good practice for the notifier to include a description of the acquisition, providing details of the shareholding and/or other rights being acquired. This will aid the ISU’s review.
- Notifiers must send a structure chart. Without one, the ISU may reject a notification, as it may not have enough information to reach a call-in decision. Structure charts should be in a chart format and include specific information (set out in the market guidance notes).
- In some cases, the Government will accept one notification for multiple acquisitions. These include where a single buyer is acquiring multiple targets from a single seller, and where a single buyer acquires control over various entities in a chain of legal entities. However, if a single buyer is acquiring multiple targets from different sellers, each acquisition must be notified separately.
- If a person is notifying multiple acquisitions in a single notification and some of those acquisitions require mandatory notification whilst others do not, the notifier should complete a mandatory notification form and include details about the acquisitions they are notifying voluntarily.
- Internal reorganisations are not exempt from notification. The guidance notes that there may be rare cases where the acquisition of control over an entity by a person in the same business group raises national security risks, even if the ultimate beneficial owner remains the same.
- The Government will not publish information on individual notifications. It will not publish details of interim orders, but it may choose to state that one has been made.
- It may, however, choose to publish information regarding call-in notices or clearances following a review. This will normally be where the parties disclose the information, or the acquisition is in the public domain and the Government considers it is in the public interest to make an announcement.
- If it does choose to make a proactive announcement, it will ordinarily try to provide advance notice to the parties and to make the announcement when the relevant markets are closed.
The Government has said it welcomes suggestions for topics to include in future market guidance publications.
Separately, the Government has published new guidance on when the regime applies to new-build downstream gas and electricity assets and updated its guidance on notifiable acquisitions to clarify when an acquisition in the downstream oil sector will be subject to mandatory notification.
Claim against investor under investment agreement was barred by rule against reflective loss
The High Court has held that continuing shareholders of a company in which a new investor took a 50% stake were prevented from claiming against the investor due to the rule against reflective loss.
Burnford and others v Automobile Association Developments Ltd  EWHC 368 (Ch) concerned a company that operated an online vehicle administration and service booking platform.
In 2015, the company’s shareholders entered into an investment agreement with Automobile Association Developments Ltd (AADL), a subsidiary of the Automobile Association (AA). Under that agreement, AADL took a 50% equity stake in the company and the shareholders granted AADL a call option over the remaining 50%.
In 2017, the company went into administration. Another company in the AA’s group subsequently bought the company’s business from the administrators at a price substantially lower than the company’s value at the time AADL had invested in it. The company was dissolved in 2019.
The former shareholders of the company brought claims against AADL. Specifically, they alleged that:
- AADL had made a number of fraudulent or negligent misrepresentations about the amount of business the AA would pass to the company; and
- AADL had breached the investment agreement (as a related licence agreement) by “pursuing a course of conduct that undermined the basis of the arrangements” between the parties and the company.
AADL responded with a single defence: that the claims were barred by the so-called “rule against reflective loss”.
What is the rule against reflective loss?
It is a basic and fundamental tenet of English law that a company is a legal person separate from its shareholders, and that, where a company and its shareholders suffer a wrong, each of them is entitled to bring their own claim. However, this is modified by the “rule against reflective loss”.
The rule (also known as the rule in Prudential) applies where both a shareholder of a company and the company itself have suffered loss and both have a claim against the same third party in respect of the same “wrongdoing”.
In those circumstances, the shareholder is not permitted to claim for any diminution of the value of its shareholding in the company, or for any loss of distributions (e.g. dividends), which is “merely the result of a loss suffered by the company” and caused by that third party – so-called “reflective loss”. Instead, the right to claim damages lies with the company itself.
One consequence of this is that (generally speaking) a shareholder is unable to claim for reflective loss even if the company itself declines to claim, leaving the shareholder completely uncompensated. The courts have said that this is an economic risk that a person assumes as part of their agreement to hold shares in a company, deriving from the unique relationship between a company and its shareholders.
The rule does not prevent a shareholder from recovering loss in other circumstances, such as where a shareholder has suffered a loss that is “separate and distinct” from any loss the company has suffered.
In response, the former shareholders argued that the rule against reflective loss was not relevant, because:
- they were not shareholders of the company at the time they brought their claim against AADL; and
- they were claiming in respect of misrepresentations and contractual promises made directly to them, which was a separate and distinct claim from any claim the company might have.
What did the court say?
The court agreed with AADL and dismissed the claim.
The judge said that it was not enough that the former shareholders had a separate cause of action from the company. Rather, they needed to show that the company had suffered a different loss in respect of which it was entitled to bring a claim. That was not the case here.
The judge also found that it did not matter that the former shareholders were no longer shareholders in the company. Although the company had been dissolved, there had been no change in its shareholders. If it were restored to the register today, the former shareholders would become shareholders again and would be treated as having been shareholders throughout its dissolution.
As a result, all the claims failed.
What does this mean for me?
This was a decision on an application to strike out a claim and so does not carry the same force as a judgment following a full trial. Nevertheless, it is a useful confirmation on the rule against reflective loss as it is now understood.
The outcome was not particularly surprising. The former shareholders’ claims fell very neatly within the ambit of the rule against reflective loss.
However, this case shows the importance of structuring joint venture, investment and shareholders’ agreements properly. It is not uncommon to make the company itself a formal party to these kinds of agreements and to give it the express benefit of certain contractual covenants. In doing this, however, shareholders must be very careful to ensure that, rather than bolstering their investment, they are not in fact detracting from their rights by bringing the rule into play.
Parties who are considering entering into any kind of investment in a company should consider taking certain steps.
- Clarify who the parties are. If the investee company is to be a party to the arrangements, the contractual documentation should reflect this and set out precisely which rights the company is to have and be able to enforce.
- Beware of overlap between company and shareholder rights. It is common for an investment agreement to provide rights in favour of both the company itself and one or more shareholders. This is, of course, fine and can be said to “cover all bases”. But shareholders should bear in mind that, where the company suffers a loss and has a right to recover it under the contract, the rule against reflective loss may prevent the shareholder from doing so itself.
- Deal with any potential deadlocks. This problem is exacerbated where the company becomes “deadlocked”. In this situation, the company’s board may not be able to take action to recover losses suffered by the company, yet the shareholder will also be barred from claiming by virtue of the rule. The parties will need to think of ways to address this. This might include providing for a modified decision-making process in such a situation or providing a separate right of action for the shareholder that does not overlap with that of the company.
EU court permits referral of “killer acquisition” to European Commission
The General Court of the European Union has rejected an appeal against the referral of the Illumina/Grail merger to the European Commission under the EU merger control regime.
The referral is significant because the target enterprise – Grail – does not generate any revenues in Europe and so was not subject to a filing obligation under the EU merger control regime.
However, a complainant prompted the European Commission to invite EU Member States to request a referral to it under Article 22 of the EU Merger Regulation. Article 22 allows Member States to request the referral of transactions that affect trade between Member States and “threaten to significantly affect competition” within their territory, irrespective of the extent of the target enterprise’s sales or assets.
Once nearly defunct, the Commission now encourages Member States to refer transactions under Article 22 if they involve a target whose competitive potential is not reflected in its turnover. This, in turn, provides a mechanism for the Commission to review so-called “killer acquisitions”.
A request under Article 22 must be made within 15 working days of the transaction being “made known” to the Member State. Significantly, the Court said that this 15-working day period did not begin until there had been an “active transmission of … sufficient information to enable that Member State to carry out a preliminary appraisal”, meaning that the clock might never start ticking in some cases.
For more information on the background to the referral and the judgment, see this in-depth commentary by our colleagues, Rich Pepper, Tom Usher, Christophe Humphe and Ciara Barbu-O’Connor.
Takeover Panel publishes bulletin on possible offer announcements
The Takeover Panel has published Panel Bulletin 5, which is designed to remind financial advisers of certain aspects of Panel guidance on Rule 2.2(c) of the Takeover Code (the Code).
Rule 2.2 of the Code sets out when a bidder (in Code terminology, an offeror) or a target (in Code terminology, the offeree company) is required to announce that there is an offer or possible offer in play for the offeree company.
In addition, Takeover Panel Practice Statement 20 describes how the Panel Executive will normally interpret and apply certain provisions of Rule 2. Bulletin 5 is designed to remind financial advisers of certain aspects of Practice Statement 20.
The Bulletin reminds financial advisers of certain key aspects of Practice Statement 20.
UK Secondary Capital Raising Review publishes long-awaited report
The UK Secondary Capital Raising Review (the SCRR), led by Mark Austin, has published its long-awaited report on recommendations to reform the UK’s secondary capital markets.
The SCRR was formed following the UK Listings Review, led by Lord Hill, whose final report was published in March 2021, with the objective of examining ways to improve the capital-raising process for existing publicly-traded issuers in the UK.
The SCRR has now published its report. The report recommends several very significant changes to the capital markets regime which need to be seen in the context of other recent substantial proposals for reform published by the Financial Conduct Authority and HM Treasury. It will take time to further consider and digest how these will operate in the listed company world.
In the meantime, the key recommendations from the SCRR’s report are set out below.
- The principle of pre-emption, as set out in the Statement of Principles, should be retained. However, the Pre-Emption Group (PEG) should be placed on a more formal footing, with official terms of reference and a requirement to deliver an annual report.
- The allowance for disapplying pre-emption rights should be raised from 10% to 20% (as was the case during the Covid-19 pandemic), with 10% available for general use and 10% available for an acquisition or specified capital investment. Similar conditions would apply as during the pandemic, including making the issue, so far as possible, on a “soft pre-emptive” basis.
- Companies should be required to report publicly on how a non-pre-emptive issue was carried out using a short, template form available from PEG. This would be published during the week after the placing and filed in a publicly accessible database maintained by PEG.
- “Cashbox placings” should be used only up to the amount of the pre-emption disapplication authority that has been granted by shareholders at the company’s most recent annual general meeting, as a mechanic to increase the company’s distributable reserves.
- The 20% threshold should be raised to 75% for particularly “capital-hungry” companies. The company would need to make an appropriately compelling argument for the enhanced authority to persuade its shareholders to approve it. Newly listed companies should be required to state their intentions for any enhanced authority in their IPO documentation.
- Companies should give due consideration to the interests of retail shareholders and how to involve them in an offer as fully as possible. This might include using an existing technology-driven market provider or solution or including a follow-on offer that takes place after the institutional offer closes. The SCRR recommends limiting any follow-on offer to 20% of the size of the placing, with a monetary cap of £30,000 per investor.
- Where an IPO involves a retail offer, the period during which the prospectus must be made available to the public should be reduced from at least six working days to a maximum of three working days before the end of the offer.
- The threshold below which a prospectus is not required for a secondary capital raise should be increased materially from the current 20%. The report recommends linking the threshold to where an issue of shares of at least 75% of the existing share capital is involved.
- A company should not need to appoint a sponsor for a secondary fundraising, unless the company is issuing a circular (as would be the case on a secondary offer linked to a material acquisition). The existing working capital due diligence approach should be expanded from placings to all secondary fundraises.
- A company should be able to give a clean working capital statement supported by assumptions.
- The working group set up by the Financial Conduct Authority and the Financial Reporting Council should rapidly progress its work to address overlap between working capital diligence and the work required to give going concern statements and viability statements (and, in due course, resilience statements).
- The offer period for rights issues and open offers should be shortened, so that an offer is open for acceptance for seven business days, rather than ten business days.
- The Secretary of State should be given the flexibility to reduce the notice period for general meetings (other than annual general meetings) from 14 clear days to seven clear days.
- Companies should be able to seek annual allotment and pre-emption rights disapplication authorities for not only rights issues but all forms of fully pre-emptive offers. This would still apply to up to two-thirds of existing share capital under Investment Association guidelines.
- The pre-emption provisions in the Companies Act 2006 should be aligned to the process usually followed on a rights issue or open offer. For example, companies should have flexibility to exclude shareholders in overseas jurisdictions, deal with fractional entitlements through aggregating and selling them, and to offer new shares to warrantholders.
- The listing regime should permit companies to allow shareholders to apply to take up shares that are not taken up by other shareholders, at the offer price.
- Companies should be able to “opt in” to an enhanced continuous disclosure regime which they can rely on when conducting a fundraise. This would involve greater disclosure in the annual report in certain areas and, potentially, more periodic updates and website disclosure.
- There should also be a greater choice of structures available to UK issuers to use. This could involve adopting various features of Australian capital-raising models, such as a “cleansing notice”, where a company confirms, at the time of the fundraise, that it has made all required disclosures and is not withholding any inside information.
- The existing regime under section 793 of the Companies Act 2006 should be updated to require the disclosure of the identity of the ultimate investment decision-maker or beneficial owner in relation to a share. This will help to identify institutional and non-institutional shareholders in the context of fundraisings.
- Standard form terms and conditions with institutional investors for use on secondary fundraises should be agreed and made available publicly. This will remove the need to agree any bespoke terms with investors at the time of a transaction, reducing cost and increasing speed.
- The digitisation of share ownership should be prioritised through the creation of a new Digitisation Task Force. The practice of holding certificates should be eradicated whilst preserving the rights to vote, receive information and participate in corporate actions. Intermediaries should be required to provide underlying beneficial owners with the option to attend meetings, vote, receive information and participate in fundraisings.
The Government has already responded to the last recommendation by publishing the terms of reference of the Digitisation Task Force, to be headed by Sir Douglas Flint, former group chai of HSBC Holdings and current chair of Standard Life Aberdeen.
The new Task Force will be tasked with identifying ways to improve on the current intermediated system of share ownership, eliminate the use of paper share certificates for traded companies, and consider whether digitisation can be extended to newly-formed private companies.
Of the remaining recommendations, some are capable of being implemented immediately or in the short term with minimal or no legislation. Others will require formal amendments to statute and will take longer. We await the Government’s next steps in response to the SCRR’s report.
EU expands sustainable activity taxonomy to include nuclear and natural gas
The European Commission has published new legislation to expand the list of economic activities that can be considered “environmentally sustainable” for the purposes of the EU Taxonomy Regulation.
The Taxonomy Regulation and the related EU Sustainable Finance Disclosure Regulation (SFDR) require certain companies listed in the European Union to disclose the proportion of their activities that are linked to certain environmentally sustainable economic activities (ESEAs).
The Regulations also require certain financial services firms to disclose details of their investments in economic activities that contribute to an environmental objective and how those investments link to ESEAs.
The new legislation introduces new categories of ESEA to cover certain nuclear and natural gas energy activities. Broadly speaking, these activities qualify as ESEAs only if they contribute towards the transition to climate neutrality.
The Regulations do not apply to companies listed solely in the UK (although the UK is developing its own version of the Taxonomy Regulation). However, they will apply to any funds that are marketed within the EU, and UK firms and listed companies may face pressure from investors (particularly EU-based funds) to adopt certain aspects of the regime on a voluntary basis.
Financial Conduct Authority publishes 2021/2022 annual report
The Financial Conduct Authority (FCA) has published its annual report for 2021/2022.
The report sets out the significant projects on which the FCA has worked during the year and how the FCA has performed against its objectives.
In the context of the UK’s capital markets, the report notes that the FCA implemented new Listing Rules permitting special-purpose acquisition companies (SPACs) to list in a wider range of circumstances. Following this, between August 2021 and March 2022, three SPACs were listed under the new rules. The amount raised on each listing was between £115m and £175m, which was larger than the recent average size in the UK.
In addition, the FCA’s data on market cleanliness showed improvements in tackling market abuse. It will continue to undertake surveillance of security prices and capital market news-flow in primary markets with the aim of ensuring that inside information is announced on a timely basis and through the proper channels.
Takeover Panel publishes 2021/2022 annual report
The Takeover Panel has published its annual report for 2021/2022.
As usual, the report contains a useful summary of the Panel’s structure and its various committees, changes to its staff, projects the Panel has worked on during the year and statistics for takeovers activity in the UK.
In particular, the report notes that the Panel Executive spent significant time and resources on investigations into the alleged existence of undisclosed concert parties and on investigating and, where appropriate, applying sanctions in respect of other breaches of the Code. During 2021/2022, it issued one letter of private censure and four “educational/warning letters”.