The ripple effect: Offshore implications of the English Supreme Court decision in the Enviroco case

Transcription

1 BERMUDA BRITISH VIRGIN ISLANDS CAYMAN ISLANDS CYPRUS DUBAI HONG KONG LONDON MAURITIUS MOSCOW SÃO PAULO SINGAPORE conyersdill.com April 2011 The ripple effect: Offshore implications of the English Supreme Court decision in the Enviroco case In its judgment handed down on 6 April 2011 in the case of Farstad Supply A/S v Enviroco Ltd [2011] UKSC 16, the English Supreme Court has unanimously upheld the Court of Appeal s decision. 1 The dispute concerned the issue of whether a company, whose parent company had transferred the title to its controlling shares in the company by way of security to a lender, remained a subsidiary of the parent company for the purposes of Section 736 of the UK Companies Act 1985 ( CA 1985 ). Overturning the previous High Court decision, the Court of Appeal had ruled in 2009 that the parent company was no longer a member of the underlying company and therefore that the underlying company was no longer its subsidiary. This was despite the fact that the former parent company still controlled its former subsidiary for all practical purposes. In dismissing the appeal, the Supreme Court took a literal interpretation of what it accepted may have been an unintended loophole given the highly unusual circumstances of the case. By analogy, this construction of Section 736 of the CA 1985 may also have implications for the laws of offshore jurisdictions whose company law is derived from that of the UK. This article contains an analysis of the impact (if any) of the ruling on the laws of Bermuda, the British Virgin Islands, the Cayman Islands and Cyprus. 1 Enviroco Ltd v Farstad Supply A/S [2009] EWCA Civ 1399

2 Background Farstad Supply A/S ( Farstad ) was the owner of an oil rig supply vessel which it chartered to Asco UK Limited ( Asco Sub ), a subsidiary of Asco plc ( Asco Parent ). Asco Sub engaged Enviroco Limited ( Enviroco ) to clean the vessel s oil tanks while it was in port. During the cleaning process the vessel caught fire, killing one of Enviroco s employees and causing substantial damage. The English lawgoverned charterparty contained an indemnity from Farstad against various liabilities in favour of Asco Sub and its affiliates. Affiliate was defined as including a subsidiary of a company of which Asco Sub was also a subsidiary. Subsidiary was in turn defined by reference to the definition of that term in Section 736 of the CA Farstad brought a claim in negligence against Enviroco for the losses it had suffered. Enviroco sought to rely on the indemnity in the charterparty, arguing that that it was a subsidiary of Asco Parent and therefore an affiliate of Asco Sub. The case therefore turned on whether or not Enviroco was a subsidiary of Asco Parent. Asco Parent owned only 50% of the shares (and votes) Enviroco with the other 50% held by Asco Parent s joint venture partner. Enviroco s articles of association gave Asco Parent the right to appoint a majority of the directors and as a matter of contract (pursuant to a separate joint venture agreement), Asco Parent was also entitled to exercise a majority of the voting rights. Asco Parent had pledged its shares in Enviroco to the Bank of Scotland (the Bank ) pursuant to a Scots law share pledge. Asco Parent was no longer the registered holder of the pledged Enviroco shares since they had been registered in the name of the Bank s nominee pursuant to that agreement. Until the security became enforceable, Asco Parent retained the full voting and other rights and powers in respect of the pledged shares as the Bank s proxy, subject to a proviso that these powers should not be exercised in a manner which would adversely affect the value of the security or result in the shares being registered in the name of anyone else. Statutory framework Section 736(1) of the CA 1985 provides that a company is a subsidiary of another company (its holding company ) if that other company: (a) (b) holds a majority of the voting rights in it; or is a member of it and has the right to appoint or remove a majority of its board of directors; or Page 2 of 10

3 (c) (d) is a member of it and controls, alone, pursuant to an agreement with other members, a majority of the voting rights in it; or is a subsidiary of a company which is itself a subsidiary of that other company. No reliance was placed by Enviroco on the other limbs of Section 736(1) in (a) or (b), presumably because Asco Parent did not itself own a majority of the shares in Enviroco and did not have control for those purposes except with the assistance of others (namely, the joint venture partner). Enviroco argued instead that it was a subsidiary by virtue of Section 736(1)(c). It was not in dispute that through the joint venture agreement, it satisfied the test relating to control of the voting rights, so the test would be satisfied if it was also a member of Enviroco. Section 22 of the CA 1985 states that a member is anyone whose name is entered in the register of members. Section 736A(7) provides that rights (such as voting rights) attaching to shares held by way of security are treated as held by the security provider and not the secured party, where, apart from the right to exercise them for preserving the value of or realising security, such rights are exercisable only in accordance with the security provider s instructions. Enviroco sought to argue that a parent company providing security remains a member of the secured shares by relying on Section 736A(7). Case history The question was whether satisfying the test in Section 736A(7) was sufficient for Asco Parent to qualify as a member of Enviroco for the purposes of Section 736(1)(c) and thus classify Enviroco as its subsidiary. The High Court held that this was sufficient since Asco Parent retained its voting rights in respect of the shares transferred to the Bank. However, in overturning this decision, the Court of Appeal held that at the point Asco Parent transferred its shares in Enviroco to the Bank and the name of the Bank s nominee was entered in the register of members, Asco Parent had ceased to be a member of Enviroco. Accordingly, Enviroco no longer qualified as Asco Parent s subsidiary within the meaning of Section 736(1)(c) of the 1985 Act and therefore could not rely on the indemnity in the charterparty. The Court of Appeal and the Supreme Court both drew a distinction between membership of a company, which is a status derived from entry of the shareholder s name in the register of members on the one hand, and rights attaching to such shares (as referred to in section 736A(7)) on the other. Section 736A(7) had arguably sought to ensure that a person providing security over shares of an underlying company Page 3 of 10

4 continued to be treated as the holder of the shares, by treating rights attaching to the shares as being held by the security provider. However, in order fall within Section 736(1) the holding company must also qualify as a member of the subsidiary, meaning that it must be registered in the register of members as the holder of shares in the subsidiary within the meaning of Section 22. Both Courts noted that the mere fact that the provisions of a statute may operate to produce uncommercial results does not empower the judiciary to redraft the provisions on policy grounds. Relevance to offshore jurisdictions The case concerned the interpretation of the relevant provisions of the CA 1985 and the ruling remains a live issue in the UK since those provisions have since been reproduced in the Companies Act 2006 ( CA 2006 ). The ruling will also affect companies in offshore jurisdictions whose status as subsidiaries and holding companies is derived from legislation similar to that of the UK. In such jurisdictions, decisions of the English courts in relation to analogous statutory provisions will be regarded as highly persuasive. Although the circumstances of the case were unusual, it may be that the legislature will intervene in the UK to address the potential consequences of this ruling. Whether or not this should be the case, the impact of Enviroco for the purposes of the Bermuda, BVI, the Cayman Islands and Cyprus statutes differs depending on how closely the definition of subsidiary aligns to the UK statutes. Bermuda The equivalent Bermuda company law provision, Section 86 of the Companies Act 1981, is couched in terms which have no direct equivalent in current or former UK statutes and the test is focussed on substantive control rather than membership. Since no part of the statutory definition of subsidiary in the Bermuda legislation depends directly on the concept of membership, the Enviroco ruling does not appear to be relevant to Bermuda companies. British Virgin Islands In the British Virgin Islands, Section 4 of the BVI Business Companies Act 2004 is substantially similar to Section 736(1) CA 1985 and the reference to company in the BVI test expressly includes a foreign company as well as any other body corporate. There is, however, notably no BVI equivalent to the other provisions of Sections 736 Page 4 of 10

5 and 736A of the CA The definition of shareholder is substantially similar to the UK definition, namely a person whose name is entered in the register of members. Due to the similarities between the relevant provisions in the UK and the BVI statutes, most of the comments made on the impact in the UK will apply equally to the BVI. However, there may be some instances where the BVI courts have freedom to distinguish the case on the grounds that the BVI has no equivalent to Section 736A CA 1985 (now Schedule 6 of the CA 2006). Cayman Islands There is no standard definition of a subsidiary under the laws of the Cayman Islands and as such, no universal understanding of what the term means. Although the term is defined for certain specific purposes, they are very unlikely to be relevant as they either apply for particular provisions (such as mergers) or on a local basis only. The Enviroco case is therefore unlikely to be of relevance to Cayman Islands companies. Cyprus In Cyprus, the basic definition of subsidiary in Section 148 of the Cyprus Companies Law, Cap. 113 (as amended) is substantially similar to Section 736(1). However, the rest of the section follows the old Section 154 in the Companies Act 1948 (the precursors to Section 736 and 736A prior to their amendment in 1989) and includes express deeming provisions in respect of shares held by fiduciaries, nominees and by way of security which are treated as being held by the beneficial owner or security giver. Although the definition of member in Section 27 of the Cyprus Companies Law is similar to the UK definition, it is deemed to include nominees or banks for the purposes of the subsidiary test. The loophole which arose in Enviroco should therefore not be relevant to the Cyprus company law definitions of subsidiary and holding company. Analysis of impact There has been a great deal of commentary on the impact of the case in the UK since the Court of Appeal handed down its judgment back in As the decision turned on the fact that another person had been registered in Envirocoʹs register of members, the case has implications for BVI companies wherever legal title to shares is to be passed to a third party other than on an absolute basis. The main examples of such transfers arise in the context of a security interest or a nominee arrangement. The case may also have relevance more generally offshore, to the extent that Page 5 of 10

6 contractual provisions affecting offshore companies refer back to the UK statutory definitions or are on similar terms. Security and nominee arrangements Although the security in Enviroco was a Scots law governed pledge of shares, the result would have been no different had it been an English law legal mortgage of shares, provided the security was perfected by registration of the shares in the name of the lender or its nominee. As is the case in England, a legal mortgage is one of the means by which security can be created over shares under the laws of the BVI. However, the impact of the ruling on security arrangements is limited, since legal mortgages of shares are relatively unusual. The vast majority of security interests over shares taken under BVI law are via share charges or equitable mortgages. Supporting documentation (such as blank share transfer forms and share certificates) is usually delivered to the lender at the outset in order to assist with any eventual enforcement, but the shares are usually not registered in the name of the lender or its nominee unless enforcement steps are taken. In the rare instance that a legal mortgage is granted by a parent company over shares in one of its subsidiaries, there is now a risk that once the security is perfected by registration of the shares in the name of the secured party or its nominee, the subsidiary will inadvertently fall out of the group (and may even become the lender s subsidiary). This risk will only materialise in particular, limited circumstances since, in practice, most parent companies own a majority of the voting shares in their subsidiaries (unlike Asco Parent which did not own a majority of the shares in Enviroco in the first place). The judgment did not consider (due to the facts of the case) the first limb of the test in sub paragraph (a) of Section 736(1), which relies only on the holding of a majority of the voting rights. It is likely that, where a majority of voting rights attaching to the secured shares are retained by the security provider, it may remain as the holding company regardless of the security holder being the registered member. As to whether the Enviroco case could possibly have been decided differently in the BVI under the equivalent BVI statutory definition, it should be noted that the BVI statute does not contain the interpretation provisions in Schedule 6 of the CA 2006 (Section 736A of the CA 1985). Therefore, Enviroco would probably have had even less grounds to claim that the BVI version of the membership test in Section 736(1)(c) had been met, given that its argument was based on an interpretation provision (Section 736A(7)) which has no BVI equivalent. On the other hand, a BVI court in Page 6 of 10

7 similar circumstances might have more freedom to take a commercial approach to the first limb of the test in Section 4(1)(a)(i) (equivalent to Section 1159(1) CA 2006 or Section 736(1)(a) CA 1985). This test requires the parent to hold a majority of the voting rights but does not include a membership condition, and unlike the UK provisions, there is no BVI definition of what voting rights means for these purposes. The Supreme Court in Enviroco did not go on to consider whether the Bank or its nominee became a holding company of Enviroco. In the circumstances of that case, and following the Court s interpretation of Section 736(1)(c), it seems quite possible that Enviroco had no holding company; there is after all no requirement that a company with corporate members should always be a subsidiary of another. The judgment however makes it clear that membership is defined by the names on the register of members without being affected by the provisions of Section 736A. This may lead to a situation where a company has more than one holding company for the purposes of the legislation. This is potentially inconsistent with the definition of wholly owned subsidiary in Section 1159(2) of the CA 2006 (Section 736(2) of the CA 1985). Applied to a situation where 100% of a company s shares are transferred by way of security and there are no other members, the company seems to become a wholly owned subsidiary of the secured party (or its nominee). The BVI has no statutory definition of wholly owned subsidiary, but this does not necessarily resolve the underlying inconsistency. In jurisdictions where this ruling is relevant, legal mortgages are likely to become even less common. Further, although some charges or equitable mortgages give the security holder the (little used) right to have the shares registered in its name prior to any default or enforcement, it seems unlikely that a security holder would do so. The flipside of the reasoning in Enviroco suggests that the acquisition by a person of voting rights (for example, under the covenants in a security document) without being registered as a member of a company should not alter a companyʹs status as the subsidiary of another company. Since, as noted above, there is no BVI equivalent to paragraph 2 of Schedule 6 CA 2006 (on the interpretation of voting rights ), or to paragraph 7 of Schedule 6 CA 2006 (which carves out rights to shares held by way of security) (both formerly in Section 736A CA 1985), care would need to be taken by a security holder that it does not inadvertently acquire a BVI subsidiary. The simplest means of addressing this risk would be to ensure that the grantor of the security (whether legal or equitable) retains its voting rights until an event of default. Page 7 of 10

8 The ruling may also apply outside of a security context where shares carrying the majority of the voting rights in a company are registered in the name of nominees or fiduciaries. Since beneficial rights are usually retained by the beneficiary, the risk of the test in Section 736(1)(a) (or its BVI equivalent) not being met only arises if those rights (especially, the majority of the voting rights and the right to control the composition of the board of directors) are also transferred to another person. The relevance of the above should not be taken out of context for BVI law purposes. The general definitions of ʺsubsidiaryʺ and holding company are fairly sparsely used in the BVI Business Companies Act 2004 (and in particular, are only relevant to Sections 120(2) and (3) relating to directors duties). Also, the definitions are not liberally cross referenced in other BVI statutes so the associated implications of this (such as in relation to VAT grouping) which have been raised in the UK do not arise. Contractual definitions The ruling will also be relevant in the context of interpreting finance documents or other contracts where terms such as member, subsidiary, affiliate, group, etc, are defined by reference to the statutory definitions. Care needs to be taken when using statutory definitions to ensure that the intention of the parties is accurately reflected in the contract, in order to avoid any inadvertent breach. Provisions which typically turn on such definitions include financial covenants and associated events of default provisions, change of control provisions, rights to assign contracts, indemnities (such as in the Enviroco case), representations, warranties and limitations on liability. It should be noted that it is fairly rare for contracts to use a definition of ʺsubsidiaryʺ or holding company based on the BVI statute. From an offshore perspective, although security documents are commonly governed by the laws of jurisdiction of the company whose shares are secured, the facility agreement and related finance documents are usually governed by foreign laws. Where they are governed by English law, the UK statutory definition of subsidiary may still be used for reasons of consistency to refer to the borrower s entire group, including its overseas group members. Alternatively, however, there may a contractual provision which refers back on a generic basis to the analogous provisions of local law. Since the terms of contractual provisions are generally within the control of the parties, it is possible to address this with appropriate drafting. Where the terms ʺsubsidiaryʺ and ʺholding companyʺ are defined in agreements by reference to the statutory definitions, it may be prudent to ensure that the relevant definitions are Page 8 of 10

9 extended to include companies which granted legal mortgages over shares or simply transferred them into the name of a nominee. A specific ʺdeeming provisionʺ can be added so as to provide that that a company is treated, for the purposes only of the statutory membership test, as a member of another company even if its shares in that other company are registered in the name of another person (or its nominee), whether by way of security or in connection with the taking of security, or its nominee. This had already started to become standard even before confirmation of the Court of Appeal s decision by the Supreme Court and it is likely to become increasingly widespread. This is clearly a more simple exercise in relation to the entry into new agreements, as opposed to the amendment of existing ones. Conclusions There has been a great deal of commentary on the UK position since the Court of Appeal handed down its judgment back in As between Bermuda, the BVI, the Cayman Islands and Cyprus, this ruling appears to be of most relevance to the BVI, where the statutory definitions of subsidiary and holding company are most similar to those used in the UK statutes. It is, however, unlikely to have any impact on the position in Bermuda, the Cayman Islands or Cyprus except to the extent that any contractual definitions refer back to UK statutory definitions or are on similar terms. Legal advice should be sought in the relevant jurisdictions before shares or voting rights are transferred on a temporary basis, pursuant to security arrangements or otherwise, which could have an impact on a company s status as a subsidiary or holding company for BVI law purposes. In reality, however, the relevance of Enviroco as a matter of BVI law should not be overstated since: It is likely to be limited to situations where the beneficial owner of shares has transferred the legal title to a nominee or by way of security and the rights attaching to the shares do not, in and of themselves, carry the majority of the voting rights in the company. A company s technical status as a subsidiary or holding company of another has limited effect as a matter of BVI law, since these definitions are so little used in the BVI statutes. Parties to security or nominee documentation may nonetheless take a cautious approach and avoid taking certain courses of action (e.g. lenders are likely to continue to prefer equitable over legal security unless the latter is required by commercial imperatives or foreign laws). Page 9 of 10

10 The case may have wider implications for contracts which use the BVI statutory definition of ʺsubsidiaryʺ, expressly or by implication, although this practice is relatively unusual. Where relevant, contractual references to statutory definitions of subsidiaries and holding companies can be adjusted by mutual agreement of the parties. As such, it is difficult to see the Enviroco decision having wide reaching ramifications for BVI law purposes, but those which do exist will need to be kept in mind by practitioners. Claire McConway Associate +7 (495) This article is not intended to be a substitute for legal advice or a legal opinion. It deals in broad terms only and is intended to merely provide a brief overview and give general information. About Conyers Dill & Pearman Conyers Dill & Pearman advises on the laws of Bermuda, British Virgin Islands, Cayman Islands, Cyprus and Mauritius. Conyers lawyers specialise in company and commercial law, commercial litigation and private client matters. Conyers structure, culture and expertise enable responsive, timely and thorough service. Conyers provides clients with the highest quality legal advice from strategic global locations including offices in the world s leading financial centres in Europe, Asia, the Middle East and South America. Founded in 1928, Conyers comprises 600 staff including more than 150 lawyers. Affiliated companies (Codan) provide a range of trust, corporate secretarial, accounting and management services. For more information please contact: Naomi Little +1 (441) naomi.little@conyersdill.com Page 10 of 10