One subject that may puzzle those approaching London Registrars for commercial law consultancy services is that of intra-group transfers of assets – including shares in other group companies – by sale or distribution. While such transfers are common in corporate transactions such as group restructurings, demergers and pre-sale reorganisations, ensuring that such transfers are at ‘market value’ has long worried some company directors.
Of course Directors are often anxious to make sure an intra-group transaction in which they are involved is lawful, and the test to be applied in determining this was clarified somewhat by the decision of the Supreme Court in the 2010 case, Progress Property Company Limited v Moorgarth Group Limited. In that case the Supreme Court rejected the argument that an objective approach should be taken when a company enters into a transaction with a shareholder that results in a transfer of value not covered by distributable profits, regardless of the transaction’s purpose.
Common law dictates that it is illegal for a company to make a distribution out of capital. This means that in the event of a company lacking positive distributable reserves, it is unable to make a lawful intra-group transfer for anything less than market value. The background to the Progress Property case was that Tradegro (UK) Ltd (Tradego) had agreed to sell its majority stakeholding in Progress Property Company Ltd (‘PPC’) to the holder of the remaining shares in the company.
However, a condition of the transaction was that before completion, PPC would sell its subsidiary, YMS Properties (No 1) Ltd (‘YMS’) to Moorgarth Group Ltd (Moorgarth), which was another subsidiary of Tradego. It was believed that there were indemnity and counter-indemnity arrangements between the companies that were released in exchange for a substantial cut in the sale price – only for it to later emerge that the indemnity had never been entered into, meaning that the reduction in sale price was unjustified.
PPC, now under its new owners, argued that the sale of YMS was therefore grossly undervalued and that capital had been unlawfully distributed from PPC to Tradego. Moorgarth, meanwhile, said that the transaction was lawful on the basis of both PPC and Moorgarth – through their common director – genuinely believing at the time in the existence of the indemnity, which therefore meant that the sale price represented market value.
The Supreme Court ultimately dismissed PPC’s appeal, holding that there had been no unlawful distribution of capital simply by virtue of a transaction with a shareholder in which the price paid turned out to be less than market value. It confirmed that the current approach in the law was to look to the essence of the agreement and examine the transaction’s substance and purpose, rather than the form.
Such a judgement indicates that the courts are hesitant to unpick genuine commercial transactions between group companies where the directors act in good faith and reasonably believe that the transaction occurred at market value, even where such a transaction later transpires to be a bad bargain for the companies involved.