Ashurst and Practical Law Corporate Update Q3 2023

The articles below were written by Ashurst LLP and Practical Law Corporate in Q3 2023 and first published in the company law section of PLC Magazine, the leading monthly magazine for business lawyers advising companies active in the UK.

1. Asset purchase agreement: construction of buyer indemnity

The High Court has held that an indemnity, under which the buyer of a business indemnified the seller and other members of the seller’s group, covered liabilities for historic negligence arising from the mis-selling of insurance products.

Background. An asset purchase involves a buyer acquiring a collection of assets and rights from a seller, and sometimes assuming responsibility for certain liabilities, which together comprise the target business. As no assets transfer to the buyer automatically or by operation of law on an asset purchase, what the buyer receives is determined by the terms of the relevant acquisition agreement. Subject to limited exceptions, any unwanted assets, rights or liabilities often remain with the seller on completion of an asset purchase. As a result, it is common for an asset purchase agreement to include an indemnity under which the buyer agrees to indemnify and keep indemnified the seller and companies in its group against historic liabilities that remain with the seller.

Facts. A large insurance group, R, sold certain healthcare insurance assets to C as part of a management buy-out from R. C agreed to indemnify and keep indemnified R and other members of R’s group in respect of all liabilities of the transferring business other than certain liabilities specified in the business transfer agreement (BTA). The indemnity did not include clear words specifying whether it covered liability arising from negligence.

A subsidiary of R, P, was involved in selling insurance products under R’s master policies, including payment protection insurance (PPI) policies. R later sold P to L, resulting in P becoming a subsidiary of L.

P incurred losses in respect of the negligent mis-selling of PPI policies by its agent and brought a claim against C under the indemnity for amounts paid out to customers by way of redress for the mis-selling of the PPI policies. P argued that that all potential liabilities were included within the scope of the indemnity unless expressly excluded, or arising from fraud or other criminal offences, and that C had agreed to indemnify it against those liabilities.

C argued that the indemnity did not apply to liability arising from the negligent mis-selling of PPI and that, in the absence of clear wording, it should be assumed that C did not intend to indemnify P for liability arising from negligence. The commercial context made it unlikely that C would have agreed to assume responsibility for indemnifying P against its own negligence. C also argued that the indemnity was given to R and members of its group from time to time but as C was a member of L’s group when it claimed under the indemnity, it should not be permitted to do so.

Decision. The court held in favour of P.

Clear intention must appear from the words used before the court will reach the conclusion that one party has agreed to exempt the other from the consequences of its own negligence or indemnify it against any resulting losses. However, this is a starting assumption and the court will also consider the language of the indemnity, business common sense and the factual context.

Here, there was sufficient evidence to indicate that the parties had intended risk for liability arising from historic negligence to pass to C, including that:

• R had transferred the whole of the insurance business to C as a going concern, indicating that the allocation of risk was that C would assume all of the liabilities of the business going forward.
• R had transferred to C all of the liabilities of the transferring insurance business except certain defined excluded liabilities, which did not include liability arising from negligent mis-selling of PPI.
• The indemnity in the BTA did not specifically exclude liability arising from negligence, however, a similar indemnity in another related transactional agreement did so.
• In contrast to the BTA, a related reinsurance agreement entered into by the parties specifically excluded the negligent mis-selling of insurance policies.
• The BTA contained a warranty that there had been no complaints of unsuitable advice or representations relating to relevant insurance products, which indicated that the parties were aware of insurance mis-selling risks.
• The BTA had been drafted by skilled professionals, supporting the conclusion that the language used in the BTA was deliberate.

Although the definition of R’s group in the BTA was ambiguous, R’s group had included R’s subsidiaries at the date of the BTA. It was not relevant whether they remained so at the time of claim or loss. Although P was not a subsidiary of R when the indemnity claim was made, it was a subsidiary of R at the time that the parties executed the BTA. Business common sense supported this interpretation. Other parts of the BTA also indirectly supported this interpretation.

Comment. This decision highlights the importance for an indemnity to expressly deal with the issue of whether or not it covers liability arising from the negligence of a party. The indemnity should also clearly address who can benefit from it, including whether members of the indemnified party’s group are covered and whether they remain covered if they leave the group. This reiterates the importance of ensuring that the relatively innocuous definition of a party’s group is correct and reflects the expectations of the parties if a member of the group leaves it.

The decision also shows that the court will take a modern approach to interpretation, recognising that commercial parties are free to make their own bargains and allocate risks as they think fit, and that the task of the court is to interpret the words used fairly, applying the ordinary methods of contractual interpretation while attaching equal significance to the factual context and business common sense.

Case: PA (GI) Ltd v Cigna Insurance Services (Europe) Ltd [2023] EWHC 1360 (Comm).

2. Derivative claim against directors: climate change strategy

The High Court has refused to allow a claimant to continue a derivative claim against a company’s directors for alleged breaches of their duties in connection with the company’s climate change strategy.

Background. A derivative claim is a claim brought by a shareholder of a company against the directors under the Companies Act 2006 (2006 Act) in respect of a cause of action vested in the company and seeking relief on behalf of the company.

Permission from the court is not required to issue a derivative claim, but the claimant must obtain the court’s permission to continue the claim (section 261(1), 2006 Act). The court must dismiss the claim if the evidence accompanying it does not support a prima facie case for giving permission to continue the claim (section 261(2)(a), 2006 Act).

The court must take into account a number of discretionary factors, which are set out in sections 263(3) and 263(4) of the 2006 Act, when considering whether to grant permission to continue the claim, including whether the applicant is acting in good faith. The court must refuse permission if it is satisfied that a person acting in accordance with their duty to promote the success of the company under section 172 of the 2006 Act (section 172) would not seek to continue the claim (section 263(2)(a), 2006 Act).

If a claimant has been refused permission to continue a claim, they can ask the court for an oral hearing to reconsider its decision (Civil Procedure Rule 19.15(10)).

Facts. An environmental non-governmental organisation, C, which held 27 shares in a multinational oil and gas company, S, issued a derivative claim in its capacity as a shareholder against S’s board of directors, alleging that they had breached their directors’ duties relating to S’s climate change risk management strategy. The duties allegedly breached included the duty to promote the success of the company under section 172 and the duty to exercise reasonable care, skill and diligence under section 174 of the 2006 Act.

C argued that S’s directors had breached their statutory duties by failing to set an appropriate emissions target, failing to establish a reasonable basis for achieving a net-zero carbon emissions target in the climate risk strategy and not preparing a plan to comply with an order made by the Hague District Court in 2021 requiring S to reduce its carbon dioxide emissions by 45% by 2030 under Dutch law (the Dutch order). 

C sought a declaration that the directors had breached their duties and a mandatory injunction requiring them to adopt and implement a strategy to manage climate risk in compliance with their statutory duties and to comply immediately with the Dutch order.

The High Court dismissed C’s application as there was no prima facie case for giving permission to continue the claim. In particular, it held that C had failed to submit independent expert evidence showing that the directors had breached their duties by managing S’s business risks in a way that was not in the best interests of S’s members as a whole. The court noted that directors of a business of S’s size and complexity were entitled to consider a range of competing factors, the proper balancing of which was their decision and which the court was ill-equipped to interfere with. The strength of overall shareholder support for the directors’ strategic approach to climate change risk, taken from votes cast at recent AGMs pointed strongly against granting C permission to continue the claim.

C applied to the court to reconsider its decision at an oral hearing.

Decision. The court dismissed C’s application. to continue the claim. It held that the application and the evidence adduced in support of it did not disclose a prima facie case for giving permission to continue the claim.

It was not unreasonable to require C to submit substantive expert evidence at the prima facie stage. The court preferred to adopt a critical approach to evaluating the evidence submitted, meaning that it did not simply assume that the facts alleged by C were true and sought evidence that was sufficiently substantial to justify granting permission to continue the claim. Here, C’s evidence merely reflected a consensus of opinions relating to a complex series of issues and just because C understood them to be publicly accepted did not mean that those opinions could be presented as fact. C’s evidence did not challenge an inference of an ulterior motive of advancing its own policy agenda. C had been unable to show that it was acting in good faith and this counted strongly against a conclusion that it had established a prima facie case. On the evidence, an independent director, acting in accordance with their duties under section 172 would refuse to continue the claim and, therefore, the court refused C permission to do so.

Although the test for the breach of a director’s duty to promote the success of a company is a subjective one and requires proof that the director has acted other than in good faith, C had attempted to establish breach of this duty by showing that the directors had acted irrationally. However, a number of C’s submissions conflated good faith and irrationality by treating them as interchangeable concepts and although an absence of good faith might be inferred from the irrational nature of a director’s conduct, irrationality cannot stand as a ground of breach on its own. There is no breach of the duty if a director honestly but irrationally believes that a particular course of action is in the company’s best interests.

C had attempted to impose additional incidental duties on S’s directors in connection with the adoption of a climate strategy which it claimed flowed from the statutory general duties, including a duty to accord appropriate weight to climate risk and a duty to adopt strategies to mitigate climate risk. The court rejected C’s argument at the oral hearing that, even if the incidental duties did not arise in relation to the adoption of S’s climate strategy, they did so in relation to the implementation of the strategy and so, once adopted, the court could intervene and direct how the strategy should be implemented. These incidental duties did not arise on the adoption or implementation of the climate strategy as the imposition of the incidental duties would cut across the directors’ general duty to promote the success of S for the benefit of its members as a whole.

Comment. The evidence submitted by C fell considerably short of establishing that the way in which S was being managed by the directors could not properly be regarded by them as being in the best interests of S’s members as a whole. 

This decision confirms the difficulties of using the derivative claims procedure as a route to challenging the good faith decision-making of boards in relation to the climate change strategies of their companies. 

In setting company strategy, the directors are entitled to consider a range of competing factors, the proper balancing of which is their decision and which the court noted that it is ill-equipped to interfere with. Climate change risk is one of a number of risks for the board to factor into its decision making. Any attempt by an activist shareholder with a small shareholding to challenge company strategy and seek relief on behalf of a company using the derivative procedure is likely to give rise to an inference that its real interest is not in how best to promote the company’s success for the benefit of its members as a whole.

The claim has raised the profile of climate change risk with boards and the importance of developing robust climate change strategies, although companies such as S might view the action as fundamentally flawed and a misuse of the English courts.

Case: ClientEarth v Shell Plc [2023] EWHC 1897 (Ch).

3. Digitisation of shareholdings: Digitisation Taskforce interim report

The Digitisation Taskforce has issued its interim report regarding proposed reforms to the UK’s shareholding framework (the report).

Background. The Digitisation Taskforce was launched in July 2022 following recommendations to the government in the UK secondary capital raising review. The Digitisation Taskforce aims to implement the full digitisation of the UK shareholding framework by eliminating the use of paper share certificates and to overhaul the UK’s intermediated system of share ownership.

Facts. The report includes the following recommendations:

• Legislation should be implemented and amendments to company articles of association made as soon as practicable to stop the issuing of new paper share certificates.
• Legislation should be passed to require dematerialisation of all share certificates.
• The government should consult on the preferred approach to residual paper share interests and whether a time limit should be imposed for the identification of untraced ultimate beneficial owners (UBOs).
• Intermediaries should be obliged to put in place technology that enables them to respond to UBO requests from issuers in a timely manner.
• Intermediaries that offer shareholder services should be fully transparent about whether clients can access their rights as shareholders and, if so, the extent to which they can do so and any charges imposed for that service.
• Where intermediaries offer access to shareholder rights, the baseline service should facilitate the ability to vote and provide a two-way communication and messaging channel, through intermediaries, between the issuer and the UBOs.
• Following digitisation of certificated shareholdings, cheque payments should be discontinued, and direct payments should be made to the UBO’s bank account.

In addition, the report requests feedback on the following:

• The appropriate timeline to require all share certificates to be dematerialised.
• The approach that should be taken regarding residual certificated holdings.
• Whether all digitised shareholdings should be recorded in the Central Securities Depository, and managed and administered through nominees.
• Whether the facilitation of shareholder rights should be left to market forces.

The final report is expected in early 2024.

Source: Digitisation Taskforce: Digitisation Interim Report

4. Strategic reports and directors’ reports: draft regulations

The draft Companies (Strategic Report and Directors’ Report) (Amendment) Regulations 2023 (the draft regulations) have been published.

Background. The Department for Business, Energy & Industrial Strategy issued a wide-ranging white paper on restoring trust in audit and corporate governance in March 2021, and published a response to feedback on the white paper in May 2022. 

Facts. The draft regulations amend the Companies Act 2006 (2006 Act) to introduce the following new reporting requirements for companies with a high number of employees and a high level of turnover, that is, companies with 750 or more employees and an annual turnover of £750 million or more:

• Information about distributable profits, distributions and purchase of own shares as a note to the accounts.
• A distribution policy statement in the directors’ report.
• A resilience statement in the strategic report describing how principal risks are being managed.
• An audit and assurance policy statement in the directors’ report every third financial year with an update in the intervening financial years.
• A material fraud statement in the directors’ report.

If approved by Parliament, the draft regulations will come into force in January 2025, and will take effect in two stages so that they will apply to financial years beginning on or after:

• 1 January 2025 for companies whose equity share capital is admitted to trading on a UK regulated market for the whole of the financial year.
• 1 January 2026 for other in-scope companies, such as very large private companies, non-traded companies and AIM companies.

The Financial Reporting Council (FRC) plans to consult separately on detailed non-statutory guidance for companies on good practice in complying with the new reporting statements required by the draft regulations. The FRC expects to issue draft guidance for consultation by the end of 2023 or early 2024, with the guidance expected in its final form in 2024 before the reporting requirements come into effect.

Part 5 of the draft regulations provides for a review of the new sections inserted into the 2006 Act. The first review must be carried out before January 2030, with subsequent reviews at intervals not exceeding five years.

Source: The draft regulations, www.legislation.gov.uk/ukdsi/2023/9780348250220/pdfs/ukdsi_9780348250220_en.pdf

5. Corporate reporting: guidance on UK Sustainability Disclosure Standards

The Department for Business and Trade (DBT) has issued guidance on the framework to create UK Sustainability Disclosure Standards (the guidance).

Background. The International Sustainability Standards Board (ISSB) is a standard-setting board of the International Financial Reporting Standards (IFRS) Foundation, a not-for-profit organisation that sets global, corporate reporting standards, through the International Accounting Standards Board.

In June 2023, the ISSB issued its first two IFRS Sustainability Disclosure Standards: IFRS S1 "General Requirements for Disclosure of Sustainability-related Financial Information“ and IFRS S2 “Climate related Disclosures“ (together, the IFRS standards). In July 2023, the Financial Reporting Council (FRC) consulted on the government’s proposed endorsement of the IFRS standards.

Facts. The guidance explains that the UK Sustainability Disclosure Standards will set out corporate disclosures on the sustainability related risks and opportunities that companies face. The standards will form the basis of future legislative or regulatory requirements for corporate sustainability reporting.

The guidance sets out that:

• The UK Sustainability Disclosure Standards will be based on the IFRS standards.
• The Secretary of State for Business and Trade will consider the endorsement of the IFRS standards in order to create the UK Sustainability Disclosure Standards by July 2024. It is expected that UK-endorsed standards will only differ from the global baseline if necessary for UK-specific matters.
• To assist with the assessment and endorsement of the IFRS standards, and the implementation of the UK Sustainability Disclosure Standards, the government has established two committees: the UK Sustainability Disclosure Technical Advisory Committee; and the UK Sustainability Disclosure Policy and Implementation Committee, which consists of government departments and regulators, including the Bank of England, the Financial Conduct Authority (FCA), the FRC and the Treasury.
• Decisions to require disclosure under the UK Sustainability Disclosure Standards will be taken by the government, for UK-registered companies and limited liability partnerships, and by the FCA for UK-listed companies.

Source: DBT: Guidance, UK Sustainability Disclosure Standards, www.gov.uk/guidance/uk-sustainability-disclosure-standards

6. Financial reporting: climate-related metrics and targets disclosures

The Financial Reporting Council (FRC) has issued a report setting out its findings on the Task Force on Climate-related Financial Disclosures (TCFD) disclosures and 
climate-related reporting in the annual reports and accounts of 20 UK premium and standard-listed companies (the report).

Background. Comprehensive, high-quality and internally consistent climate-related disclosures can lead to greater transparency about companies’ responses to the risks and opportunities posed by climate change which, in turn, can help investors to make more informed investment decisions. The Financial Conduct Authority introduced specific TCFD climate-related disclosure requirements for listed companies, with the first reports issued by premium listed companies in relation to December 2021 year-ends.

In July 2022, the FRC issued a report setting out the findings of its review of both the TCFD disclosures and climate-related reporting in the annual reports and accounts of 25 premium listed companies with December 2021 year ends, which identified progress and key areas for improvement (the 2022 report).

Facts. The report sets out the FRC’s findings of the TCFD disclosures in the 2022 annual reports of 20 companies operating in the materials and buildings, energy, banking and asset manager sectors.

The FRC found that there has been an incremental improvement in the quality of reporting since the 2022 report and further transparency in companies’ statements of the extent of consistency with the TCFD framework. However, the FRC also found that many companies are struggling to communicate a clear message concerning the metrics and targets that are important for managing their climate-related risks and opportunities for their transition plans. For example, the FRC found that while most sampled companies set net-zero carbon emissions or other climate-related targets, the metrics used to track progress were sometimes unclear or lacking explanation.

The main areas for improvement include that:

• Companies should define and report on company-specific metrics and targets, beyond headline net-zero statements.
• There should be better links between companies’ climate-related metrics and targets, and the risks and opportunities to which they relate.
• Companies should explain year-on-year movements in metrics and performance against targets.
• Further transparency is needed about internal carbon prices, where used by companies to incentivise emission reduction.
• There should be better links between the climate-related targets that are reported in the TCFD disclosures and the environmental, social and governance targets that are disclosed in the directors’ remuneration report.

The report also stated that, in relation to greenwashing, the FRC will continue to challenge unclear and potentially misleading reporting.

Source: FRC: CRR Thematic review of climate-related metrics and targets

7. Non-financial reporting: ESG data distribution and consumption

The Financial Reporting Council Lab (the Lab) has issued a report on how data on environmental, social and governance (ESG) matters is accessed, collected and used by investors, and the actions that companies can take to facilitate this (the report).

Background. ESG factors are an increasingly important theme for investors, as they are using ESG data in order to get a more complete assessment of the risks and opportunities for companies.
In August 2022, the Lab issued a report on ESG data production by companies (2022 report).

Facts. The report follows up from the 2022 report by examining how investors access and collect ESG data (that is, distribution), and how they use it (that is, consumption), before identifying what companies can do to facilitate this. It includes a list of actions to facilitate the flow of data to investors and data providers. Some of these relate to the presentation of the data; for example, keeping the location and format of information for both reports and the website consistent from year to year as much as possible. Other recommended actions for companies that are highlighted in the report include:

• Understanding the audience and target accordingly. An integrated report’s audience is providers of financial capital. To target other stakeholders, companies should consider whether a standalone sustainability report is more appropriate.
• Focusing on what is relevant to the company. The annual report should focus on ESG issues that are specific to the company and how these affect the performance, business model and strategy.
• Ensuring that a coherent and interconnected narrative backs up the data. The narrative reporting messaging should be consistent with the data and financial reporting in order to avoid greenwashing and to maintain credibility.
• Providing clarity on the scope of the data. Companies should clarify whether an issue applies to the whole group or a specific geographic area or division.
• Aligning timing as much as possible. The aim should be for ESG reporting to be provided for the same period and at the same time as the annual report.
• Aiming for comparability of data presentation. Internationally recognised standards and industry frameworks should be used as much as possible.

The report also includes a set of questions for boards to ask to understand more about the company’s major shareholders and their ESG data requirements.

Source: FRC Lab report: ESG data distribution and consumption

8. Register of overseas entities: updated guidance

The Department for Business and Trade (DBT) has issued updated guidance (updated guidance) for registering overseas entities on the register of overseas entities (ROE).

Background. In August 2022, the government issued guidance for registering overseas entities on the ROE which covered, among other things, identifying and registering beneficial owners, exemptions from registration and the definition of significant influence or control.

In January 2023, the government updated its guidance for registering overseas entities on the ROE which addressed, among other things, the meaning of an overseas entity, identifying registrable beneficial owners, the meaning of significant influence or control in relation to trusts, information required for an application for registration, the updating duty, the sanctions for non-compliance and verification.

Facts. The updated guidance reflects the Register of Overseas Entities (Definition of Foreign Limited Partner, Protection and Rectification) Regulations 2023 (SI 2023/534) and the Register of Overseas Entities (Disclosure and Dispositions) Regulations 2023 (SI 2023/344), and provides further information on:

• Identifying foreign limited partners as beneficial owners.
• Removing inaccurate information from the register.
• Registering otherwise prohibited land transactions.
• Imposing financial penalties.
• Protecting information relating to an individual.
• Disclosing protected information to public authorities.

Source: DBT: Guidance for the registration of overseas entities on the UK Register of Overseas Entities, Technical guidance for registration and verification