Case study

Imperfect record keeping: Do the sellers actually own the company?

A failure in proper record keeping can result in transactions being unenforceable. In this case study, we explore an example of how Marsh advised the client to facilitate the transaction.

A failure in proper record keeping can result in transactions being unenforceable or open to challenge. That can have disastrous consequences, for example, when it comes to ascertaining who actually owns a company. This is particularly in focus where a mergers and acquisitions (M&A) transaction is being contemplated. Insurers can take the risk of an inadvertent failure to follow procedural formalities having a real-world negative impact.

A. Background

Around five years ago, a company (the ‘target’) entered several share buyback transactions with shareholders, consisting of 25% of the share capital (the ‘buybacks’). The Companies Act requires companies to maintain certain records and make certain filings surrounding buybacks but in this case, the resolutions associated with the buybacks could not be found and some of the necessary filings had not been made with Companies House.

Since the buybacks occurred, the value of the target had increased significantly. It was in the process of being sold for £35 million to a private equity fund (the ‘buyer’).

B. The risk

The sellers could argue that the buybacks were ineffectual and they remained shareholders because certain statutory and other formalities had not been fulfilled. If this argument was successful, the claimants would be able to return the money they had received for their shares and be reinstated as shareholders, owning 25% of the target. Given that the shares had subsequently increased in value, this would be an attractive option.

C. The motivation

The seller did not want to hold a very significant portion of the sales proceeds in escrow for several years.
The buyer did not want to proceed with a purchase that could leave it having paid for 100% of the target but only owning 75% of it.

D. The solution

An insurance policy was placed to protect the buyer and the target against claims being brought by the prior shareholders in respect of the buybacks. The policy would cover any damages payable or, in the event the claimants were reinstated as shareholders, reimbursement of part of the buyer’s purchase price.

As no claim had yet been threatened or litigation commenced by the prior shareholders, the pricing was only 2.75% of the policy limit.

This particular example arose in the UK but the issue is similarly relevant in a range of European jurisdictions. We have also placed similar policies where share buybacks have been purported to have being effected out of capital, rather than distributable reserves, which was prohibited by the company’s articles of association.

If you would like more information on this topic, please contact your Marsh representative.

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Article

Imperfect record keeping: Do the sellers actually own the company?

A. Background

B. The risk

C. The motivation

D. The solution

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