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My PFS - Technical news - 23/05/17

Personal Finance Society news update from 10th to 23rd May 2017.

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Share purchase for directors - no dividend policy held to be unfairly prejudicial to minority shareholders

(AF2, JO3)

It is generally well understood that, where there is no share purchase agreement between shareholders in a private company and following the death of a shareholder their shares pass to their family, then, when the shareholding is a minority holding, those who inherit the shares will be left with an asset which may have little value if no dividends are paid and where minority shareholders have little say on how the company is run. 

There are provisions in company law, namely section 994 Companies Act 2006, whereby, if the company's affairs are being conducted in a manner that is unfairly prejudicial to the interests of members (i.e. shareholders) generally or, of some of the members, such a member may bring a petition to the Court. If the Court is satisfied that the petition is well founded it may make such order as it thinks for giving relief. Such an order could regulate the conduct of the company's future affairs, require the company to refrain from doing or continuing to carry out the acts complained of, all the way to providing for the purchase of the shares of certain shareholders, even a reduction in the company's share capital.  Petitions can only be brought by minority shareholders, given that majority shareholders have the power to pass any resolution of the company by themselves. 

We don't often see decisions on such cases but a recent one provides an interesting insight into what the Court may consider as unfairly prejudicial.  The case concerned is D Booth, CR Wilkinson and J A Compton v CKF Booth and Others (2017).  The facts of the case were as follows:

DB, CRW and JAC (the petitioners) were minority shareholders in CF Booth Ltd (the Company).  This was a family company incorporated in 1949 and involved in the scrap metal business.  The business was established by Clarence Booth in 1920. Clarence died in 1980 which is when the conflict between two different branches of the family started.

The petitioners held between them 27.4% of the Company. The respondents were the majority shareholders with 65% of the shares, 5 of whom were also directors of the Company.  The petitioners and the respondents were different branches of the same family. 

Over the years the Company diversified and grew into one of the largest metal recycling businesses in Europe. From incorporation until 1985 substantial dividends were paid. In 1986 the company suffered a loss and no dividends were paid. Subsequently, despite the Company returning to profitability, no further dividends were paid.  However, the directors' remuneration increased considerably, between 2005 and 2006, from £275,000 to £820,000 and from 2007 to 2015 the annual average remuneration was about £1.6m.  The directors also had other benefits including expensive motor cars and a yacht. 

Needless to say the non-dividend policy became a basis for animosity between the two sides of the family. Some of the minority shareholders complained about being unfairly treated back in 1991.  On a couple of occasions the directors offered to buy the shares of the minority shareholders although these offers were rejected, understandably perhaps as in 2012 the directors offered to buy the shares of CRW and JAC for £50,000 when a chartered accountant instructed by them provided a valuation of between £840,000 and £1.1m.

The petitioners brought a claim under the above-mentioned section 994 claiming that they were unfairly prejudiced by the directors being excessively remunerated and by the non-dividend policy. They also claimed that the non-dividend policy was intended to enable the directors' side of the family to acquire the minority holdings at a favourable price, given that the lack of dividends would have had a negative effect on the share price.

There was no share purchase agreement although there were pre-emption rights included in the Company's Articles.

Without going into the detail of the arguments in Court, the Court decided that the remuneration paid to the directors was excessive.

As can be imagined it is not an easy task to determine what is an excessive remuneration for a director. However, there have been some guidelines laid down, notably in the case of Irvine v Irvine (2007) EWHC 1875. While clearly there can be no single figure that can be said to be "reasonable" the guidelines provide that what would be reasonable would be a fair remuneration for the work the directors undertook within a certain bracket that executives discharging similar duties would expect to receive. The Judge in this case considered evidence provided by the accountant instructed by the petitioners as well as a paper published by Deloitte LLP entitled 'Directors' remuneration in small companies'. The Judge also looked at median salaries in similar sized companies, both listed and unlisted, before he reached his conclusion that the remuneration paid to the directors far exceeded what would have been fair and reasonable. 

As for the non-dividend policy, it is clear that the declaration of dividends is within the remit of the directors and not the shareholders. The shareholders will vote on the directors' recommendation as to a dividend but cannot by themselves insist on a dividend being declared if the directors do not recommend it.

The directors in this case claimed that profits were needed for the business and that the issue of whether to pay dividends was considered by the Board more than once a year and each time the decision was made not to pay a dividend. 

The Judge accepted that the Company needed cash for investment and that it did use some of its profits for this purpose and that this might provide a reason for not paying dividends out of the profits remaining after the directors' remuneration. The excessive remuneration, which the Judge had already decided there had been, made inevitable the finding that in profitable years there would have been sufficient profits for investment if that excessive remuneration had not occurred.   In effect, there were profits available for distribution but they were instead taken by the directors for themselves.

The Court also concluded that the policy which the directors adopted of never paying dividends under any circumstances was a policy which they cannot have considered likely to promote the success of the Company for the benefit of its members as a whole, which is a duty of the directors.  This, combined with the excessive remuneration which they paid themselves, was a policy promoting the success of the Company for their own benefit and not for the benefit of the members.

It should be remembered that to prove their case under section 994 the minority shareholders must prove both unfairness and prejudice.  The Judge decided that the excessive remuneration and no dividend policies were prejudicial because the petitioners were denied a return on their investment and the balance sheet had been diminished by the excessive remuneration.  It had also been unfair because the directors had taken the petitioners' share of profits.  Therefore the statutory duties of the directors were breached. 

The only argument that the respondents succeeded on was to show that there was a limitation period and so the Judge restricted the unfair prejudice to the relevant six year period before the claim.

The Court held that the purchase of the petitioners' shares was the only possible remedy as devising a proper dividend policy would be impossible. For the purpose of valuing the Company, the balance sheet would be adjusted to add back the excessive element of remuneration taken by the directors in the six years prior to the claim. 

The petitioners argued that there should be no discount applied to the value of the shares to reflect the misconduct of the directors but the Court rejected this and said that the value of the shares should be discounted to reflect a minority holding in a private company (but not on any other basis) and the appropriate discount for the size of the shareholding was one third.  The Court decided that it should be the directors who should be buying the petitioners' shares at fair value. However, if the Company was prepared to acquire the shares (under company share purchase procedures) then that should happen.

The Judge also added that the conduct of the directors would probably justify an order to wind up the company on the "just and equitable" ground where it is not for the alternative and more appropriate relief under section 994.

While each case will always be decided on its own facts, the above decision sheds some light on the Court's approach in determining what is unfair and prejudicial to minority shareholders. Of course, it is much better to try and avoid any potential argument and litigation and have in force a proper share purchase agreement which caters for death and retirement, whether incorporated in the shareholders' agreement or as a separate agreement. And, clearly, as the above case illustrates, just because a business is a family business it does not follow that there is no need for a structured share purchase arrangement.


Employees' business expenses

(AF1, AF2, JO3, RO3)

The Treasury has extended until 10 July the deadline for submissions to the call for evidence on income tax relief for employees' business expenses.


New UK limited partnership for private funds

(AF1, AF2, JO3, RO3)

From 6 April 2017 a new form of limited partnership came into existence with the introduction of a "private fund limited partnership" (PFLP).

The Government first announced its intention to legislate for a new type of partnership at Budget 2016 and, finally, the Legislative Reform (Private Fund Limited Partnership) Order, SI 2017/514, introduced this new type of partnership structure from 6 April 2017.  This modernises the Limited Partnership Act 1907 and is intended to make the limited partnership structure more attractive for asset managers and investors.

The new structure aims to reduce various financial administrative burdens for the managers and general partners as well providing greater legal certainty for limited partners.

The following are the key points to note in relation to PFLPs.

  • PFLP will be available to private investment funds established as limited partnerships, such as private equity and venture capital funds.
  • A limited partnership (LP) must be constituted by an agreement in writing and be a "collective investment scheme" to be designated as a PFLP. The definition of a collective investment scheme is in section 235 of the Financial Services and Markets Act 2000.
  • An existing limited partnership may choose to apply for PFLP status, if it fulfils the above conditions, by application to Companies House in the UK.
  • A new LP may apply to Companies House for registration as a PFLP.

Benefits of becoming a PFLP

  • Non-exhaustive "white list" of permitted activities. In a traditional LP a limited partner may not take part in the management of the LP's business without becoming liable for the LP's debts.  For PFLPs there is a list of activities a limited partner may carry on without being considered to take part in the management and without losing its limited liability.
  • The removal of capital contributions - unlike with traditional LPs, in a PFLP limited partners are not required to contribute any capital. Any capital contributed may be withdrawn at any time.
  • Removal of some statutory duties - certain duties applicable under the Partnership Act 1890 have been disapplied for limited partners of a PFLP; for example, limited partners will not need to render accounts or other information to other partners and will not need to account for profits made in competing businesses.

In addition to the above, PFLP has no obligation to file a Gazette notice on a transfer of interest by a limited partner and is not required to file notices at Companies House of changes of the partnership business etc.  In addition, the requirement for limited partners to obtain a Court order to wind up a limited partnership where there is no general partner does not apply to PFLPs.

Judging from the content of the Regulations, there does not appear to be any disadvantages with funds registering to be designated as a PFLP and so it is expected that many funds will take advantage of this new structure.



The Bank of England sends out a subtle warning

(AF4, FA7, LP2, RO2)

The Bank of England's latest quarterly inflation report has hinted that the future path of interest rates may not be quite what the market expects.

"On the whole, the Committee judges that, if the economy follows a path broadly consistent with its central projection, then monetary policy could need to be tightened by a somewhat greater extent over the forecast horizon than the very gently rising path implied by the market yield curve at the time of the forecast."

So said Mark Carney, Governor of the Bank of England, at the presentation of the Bank's latest quarterly inflation report (QIR). In launching the May QIR, coming just five weeks before the general election, Mr Carney had to be more careful than normal that it did not ruffle any political feathers. Hence his careful words, which translated from central banker speak suggest interest rates might be higher in three years' time than the 0.5% implied by money market swap rates. This latest QIR also offers a slightly different view from that of its February predecessor in other areas:

  • For 2017, GDP growth is now forecast to be 1.9%, down 0.1% from the earlier forecast in response to the disappointing 0.3% first estimate for Q1. The Bank sees a small improvement in 2018 and 2019, but the overall result is "broadly as the Committee had expected in February".
  • As was widely expected, the Bank has nudged up its inflation forecasts: CPI is already 0.3% above target. The Bank now expects inflation to peak at close to 3% in the final quarter of the year and fall very gently thereafter. For the Bank's three-year forecast period it will remain above 2%.
  • The overshoot of inflation "is entirely due to the effects of sterling's depreciation," which the Bank will not try to counter. At the press conference Mr Carney explained that "For most of the forecast period, the economy is expected to operate with a degree of spare capacity [ie slack], justifying that some degree of above-target inflation could be tolerated."
  • One factor preventing inflation from subsiding rapidly, once the Brexit depreciation effects have fallen out of the annual figures, is the Bank's forecast that "wages will rise significantly as the output gap narrows throughout the forecast period and closes by the end".
  • In presenting the report Mr Carney said that the Bank's forecast relied on, amongst other things:
    • "a significant pick-up in wage growth;
    • no further slowing in aggregate demand;
    • the lower level of sterling continuing to boost consumer prices, broadly as projected, without adverse consequences for inflation expectations further ahead; and
    • the adjustment to the UK's new relationship with the EU being smooth."

Pessimists might feel that there is plenty of scope for at least one of the conditions not to be met.

The remarks on future interest rates were unexpected, but Mr Carney's track record on the subject suggests that the market may not place too much credence upon them.


Retail prices index - April inflation numbers

(AF4, FA7, LP2, RO2)

The CPI for April rose to 2.6% and showed prices rising by 0.4% over the month, the same as the rise between March 2016 and April 2016. The consensus had been for a 2.3% annual rate, so there was no reaction in the markets. The CPI/RPI gap narrowed by 0.1% over the month, with the RPI down 0.1% on an annual basis to 3.1%. Over the month alone, the RPI was up 0.3%.

The Office for National Statistics (ONS) newly favoured CPIH index was also flat at 2.3% for the year. The unchanged number was due to a balance between upward and downward factors:


Food and non-alcoholic beverages: Overall prices rose by 0.4% between March 2017 and April 2017, compared with a 0.7% fall a year earlier. The ONS notes that it was the first time in seven years that food prices (up 0.6%) have risen between March and April. The rises were wide-ranging across all food categories.

On an annual basis, food price inflation jumped to 1.3% in April 2017, reinforcing the idea that March marked the end of a long period of falling food prices.

Alcohol and tobacco: Overall prices rose by 1.7% between March 2017 and April 2017, compared with a 0.3% fall a year earlier. The ONS says the year-on-year difference is attributable to the timing of the introduction of Budget duty changes, which last year were picked up in the April inflation figures.

Clothing and footwear: Overall prices rose by 2.0% between March and April this year compared with 1.0% a year ago. The effects are spread across a wide range of items, principally in women's clothing.

Miscellaneous goods and services:  This category experienced an overall price rise of 0.6% between March and April 2017, the largest price rise between March and April since the CPIH first started to be measured in 2005. The greatest individual effect came from jewellery, clocks and watches though there were small upward contributions from a variety of groups.


Transport: Overall prices fell by 0.5% between March 2017 and April 2017, compared with a 1.6% rise a year earlier. The timing of Easter in April 2016 contributed to air fares rising by 22.9% on the month whereas, this year, Easter was in April and instead fares fell by 3.9% between March and April. Prices of motor fuels also fell between March and April this year reflecting falls in global oil prices whereas prices rose a year ago. Petrol fell by 1.0 pence per litre this year but rose by 0.9 pence per litre a year ago. Similarly, diesel fell by 1.1 pence per litre this year but rose by 2.0 pence a year ago.

Core CPI inflation (CPI excluding energy, food, alcohol and tobacco) was down 0.2% at an annual 1.8%. All twelve Index components were in positive annual territory, underlining how broadly the inflation picture has changed. Goods inflation rose by 0.6%, moving from 1.9% to 2.5%, while services inflation decreased by 0.7% to 2.1%.

Producer price inflation (PPI) continued to signal problems down the road. The input PPI figure dipped from 19.1% in the year to March 2017 to 17.9% in the year to April 2017. Output price (aka factory gate price) inflation fell marginally from 3.7% to 3.6%. The large gap between the two is explained by a combination of hedging, time lags and the probable absorption of some cost increases. Input prices are generally much more volatile than the output numbers.

The annual CPI figure was unchanged, as expected, but the likelihood remains of further increases throughout the rest of 2017. April will probably see a jump as Easter air fare rises return to the annual calculation. At 2.3%, inflation now matches the latest regular pay growth rate reported by the ONS (for January 2017). It is little wonder the British Retail Consortium is recording sales growth in the last quarter of just 0.1%: the squeeze is on.



TPR issues DB annual funding statement

(AF3, FA2, JO5, RO4, RO8)

The Pensions regulator has published its annual funding statement (AFS) aimed at trustees and employers of DB schemes. The AFS is primarily aimed at schemes undertaking valuations with effective dates in the period 22 September 2016 to 21 September 2017 (2017 valuations), but is relevant to all trustees and sponsoring employers of DB schemes.

The AFS highlights some of the key issues we have identified facing schemes with 2017 valuations. Schemes will have been affected differently by market conditions and the TPR's analysis has identified groups of schemes which have been impacted in particular ways. The TPR has identified actions that trustees and employers falling into those groups should take in light of that impact. Trustees and employers should use the statement to identify whether their scheme falls into those groups and take appropriate action.


TPR AE: naming and shaming

(AF3, FA2, JO5, RO4, RO8)

The Regulator's quarterly bulletin confirms that automatic enrolment has now passed a significant milestone, with over 500,000 employers having met their duties and nearly eight million of their staff now saving for their retirement

The bulletin also shows the extent of the use of the fixed penalty notices (FPNs) and escalating penalty notices (EPNs) has again increased in line with the staging profile, rising to 14,502 FPNs and 2,517 EPNs.

The Regulator has the power under s89 of the Pensions Act 2004 to name and shame those employers who fail to comply. Given the FPN fine of £400 and persistent non-compliance can result in a daily rate, depending on the number of employees for an EPN of up to £10,000, it's surprising how many employers find themselves on the list.


Consultation response and the contracting-out (transfer and transfer payment) (amendment) regulations 2017

(AF3, FA2, JO5, RO4, RO8)

The DWP had identified that for some pension schemes facing financial difficulties a solution that both protects the interests of members and ensures the sustainability of the scheme is to transfer members' rights, with their consent, to a new scheme. Whilst the current legislative regime permits transfers of active and deferred contracted-out pensions rights, with members' consent, to new schemes, it prevents the transfer of contracted-out pensions that are in payment to new schemes that have never had contracted-out provisions. The current legislation was implemented to protect contracted-out pensioners from being transferred into new schemes which may not protect their contracted-out rights. However, with the ending of State Earning Related Pension (SERP) and 'contracting-out' in April 2016, it is no longer legislatively possible to create a new scheme with contracted-out provisions in the scheme rules. That means it is currently impossible to transfer contracted-out pensioners into a new scheme even where it would be beneficial to them (i.e. potentially resulting in higher pension than if the scheme's financial difficulties would lead to their transfer into the PPF). Pensions received may therefore be lower as a result.

As a consequence and after consultation,   The Contracting-out (Transfer and Transfer Payment) (Amendment) Regulations 2017 which were laid on 26th April 2017 and will come into force on 3rd July 2017 enable schemes that were contracted-out to make transfers in respect of pensioner members into occupational pension schemes which have not previously been contracted-out.

The new regulations cover transfers of liability for, and transfer payments in respect of, guaranteed minimum pensions and in relation to transfers of liability for, and transfer payments in respect of, section 9(2B) rights.

The new regulations provide that such a transfer can be made from an occupational pension scheme where either the scheme is going through a Pension Protection Fund assessment period or where a regulated apportionment arrangement has been entered into in relation to the scheme. The transfer can only be made where the pensioner member consents in writing. In addition the member must acknowledge in writing receipt of a statement showing the benefits to be awarded in respect of the transfer. The member must also acknowledge in writing the member's acceptance that the benefits to be provided by the receiving scheme may be in a different form and of a different amount to those which would have been payable by the transferring scheme; and that the receiving scheme is not required by statute to provide for survivor's benefits in relation to the transfer.

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