“LOYALTY SHARES” AND WEIGHTED VOTING RIGHTS IN COMPANIES FORMED AND REGISTERED UNDER THE COMPANIES ACTS
In this article Martin Moore QC and Philip Gillyon consider the concept of weighted voting rights in a company formed and registered under the English Companies Acts (an English company), particularly where such rights derive from holding shares for an extended period of time; and the extent to which the adoption of such rights is open to challenge by a minority shareholder of an English company (in particular on the grounds of unfair prejudice under s 994 of the Companies Act 2006 (CA 2006)).
● In general, it is permissible as a matter of English law for an English company to provide in its articles of association that certain shares should enjoy additional, or weighted, voting rights.
● For loyalty votes to become more common, a shift in regulatory attitude will be required.
● For a minority member to bring a complaint by an unfair prejudice petition under s 994 Companies Act 2006 in respect of a proposed amendment to the articles to introduce new weighted voting rights, any of three broad grounds of challenge must be satisfied.
THE BACKGROUND: FRANCE ADOPTS AUTOMATIC DOUBLE-VOTING RIGHTS
On 24 February 2014 the French Parliament adopted the “Loi visant a réconquerir l’économie réelle” (“the law to recapture the real economy” (Law n° 2014-384, 29 March 2014)). This is widely called the “Florange” Law (as it was adopted in response to ArcelorMittal’s closure of the Florange blast furnace in northeast France in 2013).
One of the provisions in the wide-ranging Florange Law is the introduction of “time-phased voting” in the form of double voting rights for shareholders in companies listed on a regulated market who have held their shares in registered form for more than two years (referred to below as “loyalty votes” and “loyalty shares”). The two-year period begins to run from 1 April 2014 and double-voting rights will therefore automatically apply from 31 March 2016. Although certain parts of the Florange Law were struck down by a decision of the French Conseil Constitutionnel dated 27 March 2014 as being contrary to the French Constitution, the provisions relating to loyalty shares were not affected.
Under the Florange Law, the attribution of double-voting rights for listed shares is automatic once shares have been held in registered form continuously for the requisite two year period unless expressly excluded by the articles of association (or by-laws) of the company. Formerly, double voting rights could be conferred by a company’s articles of association, but were not automatic. The attribution of double-voting rights applies to all shares held for the two-year period, including shares issued as bonus shares. Any transfer of shares to which a double-voting right is attached causes the immediate loss of the right (as the enjoyment of the right is dependent on the continuous holding of the shares by the same person over the two-year period).
Article 7 of the Law amends Article L225-123 of the French Commercial Code, which now provides that:
“in companies, the shares of which are admitted to trading on a regulated market, double voting rights are automatic, unless otherwise provided for in the by-laws pursuant to a decision adopted after the enactment of the Law, for all shares fully paid-up that have been registered in the name of the same owner for two years.”
A principal reason for the introduction of automatic double-voting rights for shares held for more than two years in listed French companies appears to be to increase the influence of the French state in such companies, in many of which it is a long-term shareholder.
This aspect of the Florange Law has not been universally popular. Following the introduction of the Florange Law in France, 19 large or institutional investors (including Standard Life Investments) with total assets of €2.3trn (£1.7trn) wrote to the 40 largest companies in France listed on the CAC40 objecting to the introduction of loyalty shares and requesting that they present resolutions at their AGM to opt out of the double-voting rights provisions (amongst others) by amending the companies articles or by-laws accordingly.
The prospect of equivalent UK legislation
Prior to the UK 2015 General Election campaign, the prospect of legislation to provide compulsorily for double-voting rights being introduced in the UK appeared remote. The Kay Review of UK Equity Markets and Long-term Decision Making concluded that the introduction of such provisions by legislation “would involve practical difficulties and would be unlikely to achieve the intended effect”
(Final Report dated July 2012, para 8.32).
Be that as it may, in the 2015 general election campaign suggestions were made about possible further legislation in respect of takeovers. In particular, the Labour Party’s manifesto suggested measures to the effect that only shares held at the time of the announcement of a takeover offer can accept the offer. However, in the light of the election result, early legislative intervention in the conduct of takeovers (including in relation to weighted voting rights) seems unlikely.
Nevertheless, an English company may choose to adopt articles which provide for loyalty shares and loyalty votes. In this article we consider the extent to which that is permissible or may be open to challenge by a member of an English company.
Policy considerations for loyalty shares and loyalty votes
At first sight, loyalty shares and loyalty votes are beneficial in that they promote long-term investment and stability. On the other hand, they detract from the principle of “one share, one vote”, with the consequence that voting rights do not match the shareholders’ economic interests. There is a concern that the existence of loyalty votes: may allow particular shareholders to exercise a degree of control which is not commensurate with economic interests; detract from equal shareholder rights; and may enable one group of shareholders to benefit at the expense of others.
A further concern is that loyalty share provisions which require the shares to be held in registered form are to the disadvantage of overseas and institutional investors who do not usually hold their shares in registered form. This has been the experience in France under the Florange Law (as discussed below).
Are weighted voting rights permissible in English law?
It is interesting to note that during the 19th century it was not uncommon for joint-stock companies and statutory companies (particularly water companies) to give weighted voting rights, according to the size of the holding, so that, for example, a holding of 100 shares or less got one vote per share, whilst a holding of more than 100 shares got two votes per share.
In France the Florange Law fixes the period after which loyalty votes are exercisable at two years; and Article L.225-123§1 of the French Commercial Code preserves the effect of existing articles of association which provide for double-voting rights held by a person for two years. However, in principle there is no reason why articles of association may not:
● reduce or extend the period for which shares must be continuously held before the enhanced voting rights apply; or
● provide for a different enhancement of voting rights (eg triple voting rights).
In general, it is permissible as a matter of English law for an English company to provide in its articles of association that certain shares should enjoy additional, or weighted, voting rights. The enhancement may be of general or of limited application — ie a particular class of shares may have voting rights which are greater than one vote per share at all times and in respect of every resolution put to the vote of the members; or the increase in the voting rights attached to the shares may arise only after a specified event (such as the holding of the shares for a particular period, as under the Florange Law) or only in respect of a particular type of resolution.
The latter point was recognised by the House of Lords in Bushell v Faith  AC 1099. In that case, the House of Lords upheld the effectiveness of weighted voting rights conferred on a director by a company’s articles of association which had the effect that the director was always able to defeat a resolution to remove him from office (currently set out in s 168 CA 2006), notwithstanding that the majority of members supported the removal of the director from office. The decision of the House of Lords has been much criticised (Gore-Browne on Companies, 45th ed, Vol 1, para 13, p 13–16 states that there is much force in Lord Morris’s dissenting speech at 1106; and Gower & Davis “Principles of Modern Company Law”, 9th ed, p 411 describes Bushell v Faith as an “apparently indefensible decision”), as it frustrates the statutory power of a majority of the members to remove a director from office.
Nevertheless, Bushell v Faith recognises that under English law a company’s articles of association may validly provide for weighted voting rights and depart from the principle of “one vote per share”. Lord Upjohn summarised the position as follows (at 1109):
“Parliament has never sought to fetter the right of a company to issue a share with such rights or restrictions as it may think fit. There is no fetter which compels the company to make the voting rights or restrictions of general application and it seems to me clear that such rights or restrictions can be attached to special circumstances and to particular types of resolution. This makes no mockery of s 184 [CA 1948, now s 168 CA 2006, ie the statutory power of removal of a director]; all that Parliament was seeking to do thereby was to make an ordinary resolution sufficient to remove a director. Had a Parliament desired to go further and enact that every share entitled to vote should be deprived of its special right under the articles it should have said so in plain terms by making the vote on a poll one vote one share”.
However, the potential regulatory angle concerning companies with a split capital should not be overlooked. Regulators (including the Financial Conduct Authority) have a general dislike of split voting rights. In the UK Premium Listing Principle 3 (FCA Handbook LR 7.2.1A) provides that:
“[a]ll equity shares in a class that has been admitted to premium listing must carry an equal number of votes on any shareholder vote”. It will require a shift in regulatory attitude if loyalty votes are going to catch on for listed companies in the UK.
It follows that where a company’s articles of association already provide for weighted voting rights, a member is unlikely to have any grounds for challenging the exercise of such rights.
Introducing new weighted voting rights: the potential for challenge by members.
The more difficult question is whether the introduction of new weighted voting rights which will be enjoyed by some but not all of the existing members may be open to challenge by a minority member of the company. Unless provisions in a company’s articles of association are “entrenched” under s 22 CA 2006, they may be amended by a special resolution under s 21 CA 2006. Three broad grounds of challenge to such an amendment fall to be considered — namely, whether the introduction of weighted voting rights: (i) involves a variation of the member’s class rights which has not been properly sanctioned; (ii) is an amendment of the company’s articles of association which is not made bona fide for the benefit of the company as a whole; or (iii) involves a breach of duty by the directors of the company. If any of those grounds is satisfied, the minority member may bring a complaint by an unfair prejudice petition under s 994 CA 2006.
(i) Variation of class rights: On the present state of the authorities, a variation of the articles of association of a company to confer enhanced voting rights on one group of shareholders is unlikely to constitute a variation of the class rights of the other shareholders requiring their consent under s 630 CA 2006 in the absence of a clearly worded article so providing (White v Bristol Aeroplane Co  Ch 65 (CA); Re John Smith’s Tadcaster Brewery Co  Ch 308 (CA); and Cumbrian Newspapers Group Ltd v Cumberland and Westmoreland Newspaper and Printing Co Ltd  Ch 1 at 15. Whether an amendment of the articles of association to introduce weighted voting rights can be challenged will depend principally on whether the directors’ conduct in seeking to introduce the weighted voting rights is consistent with or in breach of the directors’ duties.
(ii) Amendment not bona fide for the benefit of the company as a whole: A resolution to amend the articles of association may be set aside on the application of a minority where it is established that the majority have failed to act “bona fide in the interests of the company as a whole” (Allen v Gold Reefs of West Africa  1 Ch 656 per Lord Lindley at 671).
The test is essentially a subjective test: if reasonable shareholders could have regarded the amendment of the articles to be for the benefit of the company, the amendment will not be set aside even if the court would not have come to the same conclusion (Citco Banking Corporation NV v Pusser’s Ltd  2 BCLC 483 (PC), applying Shuttleworth v Cox Bros & Co  2 KB 9 at 18, 23 and 27 (CA)). It is for the minority who challenges the amendment of the articles to establish that the amendment was not made for the benefit of the company as a whole (Citco Banking Corporation NV v Pusser’s Ltd, supra, at –).
There are difficulties with this test, which have led to its abandonment in Australia, not least in relation to what is meant by “the company as a whole”. In Greenhalgh v Arderne Cinemas Ltd  Ch 286 (CA), it was said that “the company as a whole” generally means “the corporators as a general body” rather than the company itself as a commercial entity and separate legal person: the test is to ask whether what is proposed is, in the honest opinion of those who voted in favour of it, for the benefit of an individual hypothetical member (see per Lord Evershed MR at 291). However, where the proposal is capable of affecting the company as a commercial entity, the court will give weight to the reasonable views of shareholders on that issue.
In practice, the court has been prepared to strike down amendments to the articles on the grounds that they were not made “bona fide in the interests of the company as a whole”, in two categories of case.
● First, the court will strike down an amendment to a company’s articles of association where it is established that the majority has been motivated by “malice” in seeking the amendment — ie by a desire to harm the minority — even if the amendment, objectively assessed, is one which might be considered by a reasonable man as being beneficial to the company. However, it is generally difficult for the minority shareholder to prove malice (see, for example, Sidebottom v Kershaw, Leese & Co  1 Ch 124 (CA) per Lord Sterndale MR at 168 and per Warrington LJ at 172; Shuttleworth v Cox Bros & Co  2 KB 9 (CA) per Bankes LJ at 17 and per Scrutton LJ at 21).
● Secondly, the court will strike down an amendment to a company’s articles of association where it is established by the minority that the amendment discriminates against the minority without in any way being “for the benefit of the company as a whole”. The amendment “must not be such as to sacrifice the interests of the minority to those of a majority without any reasonable prospect of advantage to the company as a whole” (Sidebottom v Kershaw, Leese & Co  1 Ch 154 (CA) per Lord Sterndale MR, citing Brown v British Abrasive Wheel Co  1 Ch 290 per Astbury J. In such a case, the amendment is taken to be motivated by a desire of the majority to benefit itself to the disadvantage of the minority; malice (ie a wish to harm the minority) is not required. However, if the amendment could be regarded by a reasonable man acting bona fide as being “for the benefit of the company as a whole”, it will not be struck down on this ground even though it discriminates against the minority.
The introduction of weighted voting rights attached to loyalty shares is unlikely to be struck down on this second ground as discriminating against the minority without any benefit to the company as a whole (see Rights & Issues Investment Trust Ltd v Stylo Shoes Ltd  Ch 250, in which a challenge to the increase in the voting rights conferred on a class of management shares following a takeover bid to maintain the status quo was not successful).
The position is all the stronger where the adoption of weighted voting rights is not proposed in response to an actual takeover offer, but rather as an exercise in constitutional evolution in the abstract.
(iii) Breach of duty by the directors of the company: This ground of challenge overlaps with category (ii) above. The directors of a company proposing to introduce loyalty shares and loyalty votes will need to satisfy themselves that their introduction will be consistent with the proper discharge of their duties as directors under ss 170–177 CA 2006. The directors will need to ensure that in promoting the amendment they are:
● acting within their powers (s 171);
● promoting the success of the company (s 172);
● exercising independent judgment (s 173);
● exercising reasonable care, skill and diligence (s 174); and
● avoiding conflicts of interest (s 175).
If the directors promote the introduction of enhanced voting rights in order to perpetuate or extend their own control of the company, they are likely to breach their duties under those sections and be susceptible to a challenge by a minority shareholder on an unfair prejudice petition under s 994 CA 2006.
There is a less obvious, but nevertheless possible, ground of challenge for a breach of the director’s duty to promote the success of the company under s 172 CA 2006. Under s 172 the directors must consider, in good faith, whether the creation of enhanced voting rights will promote the success of the company for the benefit of its members as a whole (having regard, amongst other matters, to the matters set out in s 172(1)(a)–(f) CA 2006). An important consideration may be the impact of such rights on attracting investment in the company, particularly for larger and listed companies. The introduction of double-voting rights may be viewed by institutional investors as a retrograde step which:
● offends against the principle of one share, one vote; and
● requires the investor to hold shares in a registered form, which may not be easy to do, particularly for overseas investors.
The operation of weighted voting rights which are already provided for in the articles of association of an English company are unlikely to be susceptible to challenge by a minority shareholder, whether on a petition under s 994 CA 2006 or otherwise. An amendment to the company’s articles of association to introduce weighted voting may be open to challenge by a minority on such a petition if the minority can establish that the introduction of such rights discriminates against the minority and is not made in good faith for the benefit of the company as a whole; or that the directors in seeking to introduce such rights are acting in breach of their duties under ss 170–177 CA 2006.
This article first appeared in Journal of International Banking and Financial Law published by Lexis Nexis.