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Key takeaways
- A company’s articles of association provided that one shareholder could force a compulsory purchase of the other shareholder’s shares if certain specified events occurred, including a material or persistent breach by the other shareholder of the shareholders’ agreement.
- One of the shareholders sought to enforce the compulsory purchase provisions based on its belief that the other shareholder had committed a material breach of the shareholders’ agreement, even though the other shareholder disputed that this had occurred and the matter had not been judicially determined.
- The court’s view was that the wording of the contract clearly required that the material or persistent breach must have actually occurred, and it was not enough that one party simply believed that there had been a breach.
- This judgment is another example of the reluctance of the courts to read language into clear and unambiguous contractual provisions, and serves as a reminder of the need to be especially careful when drafting provisions buy-out provisions and other such provisions that may be exercised in contentious circumstances.
“It is a commonplace, familiar type of contractual regime, to specify a list of trigger events and to provide that if one or more of those events occurs, certain consequences follow. It is as simple as that, and there is no arguable need to read the contract differently, or to read into it something that is not there.” – Mr Justice Baker
The English High Court recently handed down judgment in Bailey Ahmad Holdings Limited v. Bells Holding Limited [2023] EWHC 2829 (Comm), which concerned Part 8 proceedings in the Commercial Court seeking a declaration on the meaning of “Defaulting Shareholder” in a company’s articles of association. The claim was summarily dismissed.
Facts of the case
- Bailey Ahmad Holdings Limited (Bailey) and Bells Holding Limited (Bells) together owned the shares in Omer & Company Accountants Ltd (the Company) (Bailey holding 40% and Bells, 60%) and had entered into a shareholders’ agreement.
- The Company’s articles of association (the Articles) contained the following mechanism for a forced buy-out of a shareholder that breached the shareholders’ agreement (the Defaulting Shareholder) by the other shareholder (the Non-Defaulting Shareholder):
- Article 14.1 provided that a “Compulsory Transfer Event” occurred where a shareholder (i.e., the Defaulting Shareholder) “commits a material or persistent breach of any shareholders’ agreement relating to the Company to which it is a party and fails to remedy such breach (if capable of remedy) within 14 Business Days of being given notice by the other Shareholder to do so”.
- Article 14.3 provided that “A Shareholder which is not a Defaulting Shareholder (the Non-Defaulting Shareholder) may, at any time, serve written notice (a Default Transfer Notice) on the Defaulting Shareholder and the Company identifying the Compulsory Transfer Event. Upon service of such Default Transfer Notice, the Defaulting Shareholder shall be deemed to have given the Non-Defaulting Shareholder irrevocable notice offering to transfer all of the Shares held by it (Sale Shares) to the Non-Defaulting Shareholder in accordance with Article 14.5.”
- Bailey served notice on Bells purportedly under Article 14.3, asserting that Bells had committed and failed to remedy (if capable of remedy) material or persistent breaches of the shareholders’ agreement. On this basis, Bailey purported to exercise its contractual rights to buy out Bells’ shares.
- Bells denied that any breach had occurred and accused Bailey of acting in bad faith and without any reasonable basis for its allegation.
- Bailey issued a Part 8 claim seeking a declaration that it was entitled to rely on the Defaulting Shareholder forced buy-out mechanism based on its honest belief in a material breach by Bells.
- In essence the court was asked to decide what the trigger was for the Defaulting Shareholder forced buy-out mechanism:
- Bailey argued that a shareholder becomes a Defaulting Shareholder if the other shareholder forms the belief that there has been a material or persistent breach of the shareholders’ agreement (whether or not a breach has actually been committed).
- Bells argued that, since it disputed that it had breached the shareholders’ agreement, this question would have to be judicially determined in Part 7 proceedings (in Bailey’s favour), before Bells was deemed to be a Defaulting Shareholder and Bailey could rely on the forced buy-out mechanism.
The judgment
- The court summarily dismissed Bailey’s claim.
- Bailey’s attempt to read into the Articles a different meaning based on the alleged purpose of the provisions, or the practical implications of Bells’ construction, was rejected
- Bailey asserted that the purpose of Article 14 was to “provide a comprehensive self-contained set of prescriptive mechanisms to regulate the Parties’ affairs in connection with … possessing and dispossessing shares in the Company”, and that the court could therefore read the words “when one of them considers the other to have committed” into Article 14.1.1 concerning material or persistent breaches (para. 24).
- The court rejected this argument and agreed with Bells that the Articles clearly and plainly specified that a Compulsory Transfer Event had to have occurred for the Defaulting Shareholder mechanism to be triggered, and Bailey’s belief “is not referred to and does not come into it” (para. 21).
- In support of its case, Bailey argued that Bells’ construction of Article 14.1.1 could not be correct because this would mean that the Defaulting Shareholder mechanism would only be triggered once there had been a final determination by the court that a material or persistent breach had taken place, and this was not what Article 14 said.
- The court did not agree that this was a consequence of Bells’ construction. It acknowledged that a dispute between the parties over whether a relevant trigger event had occurred could result in a dispute regarding the lawfulness and legal effect of any steps taken by a party purporting to be a Non-Defaulting Shareholder under Article 14. However, that was not a reason for reading Article 14.1.1 to mean that a shareholder’s mistaken belief that a material or persistent breach had occurred was sufficient for the forced buy-out provision to be triggered.
- The court held that Bailey’s claim was not appropriate for the Part 8 procedure, which is intended for cases where there is no substantial dispute of fact or law. It summarily dismissed the Part 8 claim and left the parties to liaise and cooperate to find a solution away from court, or to bring appropriate proceedings under Part 7 if a settlement was not achieved.
Comment
- This judgment illustrates the reluctance of the courts to read language into clear and unambiguous contractual provisions based on arguments regarding the purpose of the provisions. Here, the court had no difficulty in discerning the plain and natural meaning of the Defaulting Shareholder provisions, and declined to read into these provisions language that was not there.
- The case is an important reminder of the importance of carefully drafting forced buy-out provisions in agreements between shareholders. Protracted shareholder disputes may cause serious damage to the company, and shareholders often wish to agree contractual mechanisms that allow for a quick and clean break if a shareholder dispute arises. This case illustrates some of the difficulties in ensuring that such provisions are effective – if, as appears to be the case here, there is a dispute as to whether a trigger event has occurred, the party wishing to exercise the buy-out provision is left in a difficult position where any steps it takes to exercise the provision may subsequently lead to litigation.
- Some trigger events in compulsory buy-out provisions (such as insolvency events) are inherently more objective in nature and easier to substantiate. Others are more subjective, making it more likely that judicial intervention will be required to determine whether the trigger event has actually occurred. In the context of “material breach” trigger events, one way of addressing this uncertainty is to seek to clearly define what constitutes a “material breach”, for instance by reference to specific provisions of the agreement and/or by including a financial threshold for loss.
Client Alert 2023-272
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