In February 2017, a water utility FTSE 100 company, Severn Trent, successfully completed the takeover of its supplier Dee Valley Water, for £84m. Prior to the shareholders’ meeting at which the decision was to be made on the transaction, Mr Cashmore, an employee of the Dee Valley Group, gifted 443 shares to the target company’s employees, its customers and other individuals. At an ex parte hearing, two days before the shareholders’ meeting was to take place, the company obtained a direction permitting the Chairman of the meeting to reject the votes of the members who had derived their votes from Mr Cashmore. In Re Dee Valley Group plc  EWHC 184 (Ch) the Court was called to decide on whether the exclusion of the votes of the so called ‘independent members’ from the process was legitimate. Had the votes not been excluded, the acquisition would not have been succesful at that time. The case is the first English case to deal with a share-splitting exercise by use of the ‘majority in number’ statutory requirement. The case raises the question whether share-splitting is an objectionable practice, how the notion of ‘class interests’ should be interpreted, and what is the nature of the shareholders’ meeting that approves a scheme.
My article, forthcoming in the Journal of Business Law in 2019, a draft version of which is available on SSRN, addresses the under-discussed issues relating to the use and abuse of power during the scheme approval process, and the reasons why these require closer attention than they have hitherto received. Proposals for reform centre on revisiting the utility of the numerosity test of the Companies Act 2006, and revisiting the divide between conflicting and diverging interests regarding the interpretation of ‘class interests’ at the sanctioning stage.
Share-splitting: An objectionable practice?
One of the most interesting aspects of the decision in Re Dee Valley Group plc was the evaluation of the ‘share-splitting practice’ undertaken prior to the court meeting, and what test needs to be applied to determine if the votes of the members at the court meeting were valid. Sir Geoffrey Vos highlighted important dicta of the judgments in the Hong Kong case of Re PCCW Ltd  HKCA 178, which held that share-splitting is an objectionable practice that undermines the underlying spirit of the sanction stage of the statutory scheme of arrangement, as it can be used to artificially ‘boost the number of shareholders voting in favour of a scheme of arrangement’. Despite the reliance of the court in Dee Valley on the dicta of Re PCCW Ltd, the case of Re PCCW Ltd concerned a reverse scenario of a share split used in order to save the scheme, rather than defeat it. There is hence a distinct difference on the issue of whether the jurisdictional requirements had or had not been met respectively. The court in Re Dee Valley blurred the lines between the two stages, to exercise its power to intervene at the jurisdiction stage, arguably trying to overcome issues relating to the use and abuse of the numerosity test in the statutory provisions of the Companies Act 2006.
Questioning the utility of the numerosity test is nothing new, as it has troubled other common law jurisdictions, the company law review process undertaken prior to the Companies Act 2006 [Company Law Review, 2000], and expert scholars. The test fails to reflect the reality of modern shareholding, insofar as it does not take into account the existence of nominee shareholders normally voting on behalf of dispersed beneficial owners. What PCWW Ltd shows is that a shareholder wishing to support the scheme would have equally been able to abuse the test to his advantage, by making certain that shares had been distributed to the requisite number of shareholders. The labelling of such voting as manipulative is hence open to debate and begs the question whether, if the shares had been bought and split before the court meeting was ordered, voting manipulation would have been established. Furthermore, whether a time frame can be imposed in relation to share-splitting, irrespective of examining the motivation behind it, needs to be considered. It is ultimately a question of whether latecomers to the company vote with the right mind-set, namely that of having in mind the interests of the company or class interests accordingly. The court in Re Dee Valley went above and beyond the legal requirements set out in the statute, in order to deal with the practice of share-splitting. There is no discussion relating to the crucial factor of the timing of the share donation and its relevance in determining how the shareholders voting are representative of class interests or not. It was accepted that the decision made by the Chairman to exclude the votes was justified, on the basis that the Chairman was entitled to protect the integrity of the court meeting from manipulative practices [Company Law Review 2000, 58]. However, it is highly questionable whether such authority complies with the law. The court has not sufficiently questioned the chairman’s legimitacy to discretionarily decide which shareholders are entitled to exercise their voting rights at the court meeting.
‘Motives’, ‘Interests’ and ‘Rights’: conflicting versus diverging
The existence of different motives and rights may not give rise to separate classes, but is taken into account by the court when determining what the interests of the class amount to. In the case of Re Dee Valley, it could have been argued by the Court that those seeking to frustrate the scheme were voting in their capacity as employees, subject to requesting evidence to support such a claim, and hence concluded on the existence of conflicting interests. A shareholder, who is at the same time an employee or a consumer, may well be voting with those types of interest in mind and not in the interests of the class as the common law so requires. Conclusive evidence would have however been required in order to adequately establish this, and in any case would have still been problematic insofar as the Chairman, as well as the Court in this instance, lack the authority to intervene in such a manner.
Marginally different to the notion of conflicting interests, is the notion of diverging interests that may exist among different types of shareholders, who may be voting with different conceptions of corporate benefit. The Court in Re Dee Valley acknowledges that class interests ‘may be very complex and are not always going to be purely financial’. However, gaps relating to the time horizon aspect of varied shareholders (and specifically to the long-term and short-term divide), to the risk assessment of the scheme and to the environmental, social and governance aspects underlying the transaction, may well need to be taken into consideration to assess whether the scheme is in the interests of the class.
The Companies Act 2006 provides a clear distinction between the jurisdiction and the sanction stage in a scheme of arrangement. A regulatory solution which allows for the blurring of the lines between the two stages can be found in the Australian Corporations Act 2001. The Australian legislation makes provision for the case in which the requisite majorities have not been met, and allows for a court to nevertheless sanction a scheme when exercising its discretion. In doing so, it provides the desired flexibility in terms of guaranteeing that the numerosity test can neither be manipulated to its advantage by a majority in number seeking to further the bid, nor by one seeking to prevent it. In relation to the interpretation of ‘class interests’, it is proposed that an objective test - rather than a subjective one - should be applied, which would also allow for a more balanced assessment of what is meant by ‘class interests’. Drawing inspiration from ongoing debates on modern portfolio theory and integrating environmental, social and governance concerns in investment decision-making, it is arguedI argue that it is high time for the courts to delve deeper into the meaning of ‘class interests’ to justify the wide discretion that legislation provides them with.
Georgina Tsagas is a Lecturer in law at the University of Bristol.