The devil is in the detail

From a private equity perspective a lot of the focus has been on the abolition of financial assistance prohibition, understandably given that this is largely deemed to make transactions both more costly and unnecessarily complex in their structuring especially given that the effective outcome of this extra expense and complex structuring is to ensure that financial assistance does end up being given. Fortunately, upon examination and amid much lobbying from the private equity industry in the UK, it was decided that there are sufficient safeguards within the UK legal and regulatory framework to protect shareholders and creditors should they be aversely affected by a private company providing financial assistance for the purchase of its own shares.

Note the word private, public companies, regardless of whether they are listed, will continue to operate under the present status quo and as such be prevented from giving financial assistance to buy their own shares. While this isn’t such good news for the public-to-private market in the UK, those private equity firms looking for deals in the growing secondary and tertiary buyout space (which remains firmly in the private company sphere), who currently face a complex whitewash procedure as a consequence of the refinancing element of such transactions, will see their deal timeframes and associated costs reduce considerably.

But an area that has received less attention, but that private equity practitioners should still be fully cognisant of, is the changes to Articles of Association and Memorandum of Association documents of their investee companies. The Bill is proposing merging the two documents, both of which have to be in the public domain, via UK Companies House records, into something that will be known as a Company Constitution.

“Articles of Association are the by-laws of a company and, as such, they regulate a company’s internal affairs. They will typically contain provisions about the share structure of the company, how board and shareholder meetings are to be held, voting rights at those meetings, dividend rights, share transfer rights and alike,” says Nathan Pearce, private equity solicitor at Lovells.

The Memorandum of Association, on the other hand, is probably best described as a compliment to the Articles of Association of a company in that they contain different but basic information such as the company’s name, its registered offices and what it is authorised to do, although most companies can do most things, unless they are expressly prohibited from doing so by their Memorandum of Association.

It’s assumed that any changes to Articles of Association that result from the Bill will impact on existing Articles of Association, not just those that come into existence after the Bill is ratified, but that is something that has yet to be clarified. For this reason private equity practitioners are advised to keep a watch on what changes are made to the Articles of Association, in particular the sort of protections they will contain to give investors and shareholders comfort. The reason being, that protections entrenched in a company’s Articles of Association carry far more weight than shareholder agreements.

Pearce explains: “Retaining or including a restriction in the Articles of Association about issuing more shares offers a greater level of protection to a shareholder than simply relying on a contractual restriction in the shareholders’ agreement. As a shareholders’ agreement is only a contractual document, if the contractual restriction is breached, one has to sue to enforce the contractual restriction and the action remains valid unless overturned by the court. However if such restrictions are contained in the Articles of Association the issue of more shares would not be valid as a matter of principle unless that shareholder approval had been obtained, and therefore it acts as a bigger disincentive to break the rules,” says Pearce.

Clearly it’s a more attractive place to be, where an inappropriate action is immediately recognised as being null and void because it is not allowed under the company’s Articles of Association, rather than having those protections within a shareholder agreement that has to be upheld in a court of law, which is always going to involve time and expense, as well as potentially leaving the company in limbo until a judgement is issued.

Much of what has been included in the new Bill is driven by the need to make company law relevant to the practice of running small, private companies, which are an important economic contributor and employer within the UK economy. Obviously this small to medium-sized company grouping varies from a handful to tens of employees, but even the larger private companies sometimes struggle to meet current requirements. As such, the aim of the Bill is to have theory meet practice, where practice is not harmful to any interest group. Noteworthy changes that fall into this category include scrapping of the requirement to have a company secretary, and no compulsory annual general meetings.

It is probably the existence of this practical line of thinking that has led to such disappointment on the issue of executive and non-executive directors largely retaining the status quo under the new Bill. In other words, non-executive directors, despite the wide acknowledgement that they are a finite, shrinking and consequently overused pool, will continue to be subject to the same level of censure as executive directors, even though given their absence from the day-to-day operational activities of a company they cannot realistically have the same control or understanding as executive directors. While most companies now as standard foot the costs of covering their executive and non-executive directors Professional Indemnity (PI) insurance cover, PI is limited and can only go so far in providing comfort.

The status quo has largely been retained also in respect of directors’ conflicts of interest in that provided a conflict is either declared or the director stands back from a given situation, and the Articles of Association will need to make clear which it is, a conflict of interest will not be deemed to have arisen.

There are likely to be further tweaks along the way as the Bill is still being debated. And it is unlikely to pass onto the statue books until next year, leaving private equity practitioners plenty of time to dust down their investee companies’ Articles of Association to ensure they make the grade.

To find out more

The Company Law Reform White Paper and a Small Business Summary were published on March 17, 2005 and are available at and at