Share valuation – Unlawful distribution of capital Progress Property Co Ltd v Moorgarth Group Ltd: Sup Ct (Lords Phillips (President), Walker, Mance, Collins, Clarke): 8 December 2010 Matthew Collings QC, Gabrielle Higgins (instructed by Seddons) for the appellant; John McGhee QC, Richard Fowler (instructed by Eversheds) for the respondent. The appellant company (P) appealed against a decision ((2009) EWCA Civ 629, (2009) Bus LR 1535) that there had not been an unlawful distribution of capital when the whole issued share capital of its subsidiary company (Y) was sold to the respondent company (M). All three companies were indirectly controlled by the same holding company. The sale price was calculated on the basis of Y’s open market value, subtracting liabilities for creditors and a further sum in respect of an indemnity believed to have been given by P for a repairing liability. It transpired that P had no such indemnity liability to be released from and that there was no justification for the reduction in Y’s value. P alleged that the transaction had been at a gross undervalue, relying on what the Court of Appeal referred to as ‘the common law rule’ devised for the protection of creditors, that a distribution of a company’s assets other than in accordance with specific statutory procedures constituted a return of capital which was unlawful and ultra vires. The Court of Appeal upheld the High Court’s decision that the transaction had been genuine and not ultra vires despite being at an undervalue. P contended that an objective approach was required and that any such transaction which resulted in a transfer of value not covered by distributable profits, regardless of its purpose, constituted an unlawful return of capital. Held: Whether a transaction infringed the common law rule against unlawful distributions was a matter of substance, not form. The label attached to the transaction by the parties was not decisive, Ridge Securities Ltd v Inland Revenue Commissioners  1 WLR 479 ChD, Aveling Barford Ltd v Perion Ltd  5 BCC 677 ChD, and Halt Garage (1964) Ltd, Re  3 All ER 1016 ChD applied (see paragraph 16 of judgment). The essential issue therefore was how the sale of Y was to be characterised. A relentlessly objective rule would be oppressive and unworkable and would cast doubt on any transaction between a company and a shareholder, even if negotiated at arm’s length and in good faith, where the company proved with hindsight to have got significantly the worst of the transaction (paragraph 24). If it was a stark choice between a subjective and an objective approach, the least unsatisfactory option would be the latter but the court’s real task was to inquire into the true purpose and substance of the impugned transaction. That approach called for an investigation of all the relevant facts, which could include the state of mind of the persons orchestrating the transaction. That state of mind could be totally irrelevant. A distribution described as a dividend but actually paid out of capital would be unlawful, however technical the error and well-meaning the intention. However, the participants’ subjective intentions would sometimes be relevant, and a distribution disguised as an arm’s length commercial transaction was the paradigm example. If a company sold to a shareholder at a low value assets which were difficult to value precisely but were potentially very valuable, the transaction might call for close scrutiny. The company’s financial position and the motives and intentions of its directors would be highly relevant. If the conclusion was that it was a genuine arm’s length transaction, then it would stand even if it appeared with hindsight to have been a bad bargain. If it was an improper attempt to extract value by the pretence of an arm’s length sale, it would be held unlawful. It would depend on a realistic assessment of all the relevant facts, not simply an isolated retrospective valuation exercise, Clydebank Football Club Ltd v Steedman (2002) SLT 109 OH applied. In the present case, there had been concurrent findings that the sale of Y was a genuine commercial sale (paragraphs 27-29, 31-33). Appeal dismissed.
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