In March 2023, the High Court (“Court”) assessed a company’s articles of association (“Articles”) due to a claim from a private equity investor in the company that the conversion of preference shares into ordinary shares constituted a variation of the rights to which the preference shares were subject. The investor argued that the share conversion was void as the conversion was not undertaken in accordance with the provisions of the company’s Articles, and the Court ultimately agreed.
The medical and health technology company, DnaNudge Limited (“Company”), looked to raise funding from investors due to a substantial contract to supply clinical products to the NHS. This resulted in two investors, Ventura Capital GP Limited (“Ventura”) and Sumitomo Mitsui Trust Bank (“SMTB”) investing £44m in aggregate and in return acquiring preference shares, being the Series A shares, in the Company. As Ventura and SMTB held all of the preference shares in the Company and were in agreement that the share conversion was void, Ventura acted as the claimant on behalf of both affected parties.
Ventura and SMTB were party to an amended shareholders’ agreement and Articles which included various preferential rights attached to the shares they acquired, over and above the rights enjoyed by the ordinary shareholders. Such preferential rights included a put option in the event that a qualifying IPO didn’t occur by a specific date, and the rights to appoint a director.
The amended Articles contained two articles in particular that were the subject of contention in this case; Article 9.2 and Article 10.1:
All Series A Shares shall automatically convert into Ordinary Shares:
(a) upon notice in writing from an Investor Majority at the date of such
notice (the ‘Conversion Date’); or
(b) immediately upon the occurrence of a Qualifying IPO.
Whenever the share capital of the Company is divided into different classes of shares, the special rights attached to any such class may only be varied or abrogated (either whilst the Company is a going concern or during or in contemplation of a winding-up) with the consent in writing of the holders of more than 75 per cent in nominal value of the issued shares of that class.
In May 2022, the Company sent a circular to all shareholders, which, amongst other matters, stated that “an Investor Majority might seek to nullify the Put Option by converting the Series A Shares into Ordinary Shares (pursuant to Article 9.2), ahead of any exercise of the Put Option” as the put option was determined a risk factor in the Company’s proposal to raise additional working capital. However, the circular also acknowledged that “ The former holders of the Series A Shares might seek to challenge (or otherwise bring legal proceedings in respect of) any conversion of the Series A Shares (and Ventura have indicated that such a challenge and/or legal proceedings would be likely).”
Despite this, later in May 2022, a number of ordinary shareholders signed a letter to the Company that gave notice requiring the preferred shares to be converted into ordinary shares pursuant to Article 9.2. The ordinary shareholders satisfied the definition of “Investor Majority” without needing the approval of Ventura or SMTB, as “Investor Majority” was defined as being “the holders of a majority of the Series A shares and Ordinary Shares in aggregate as if such Shares constituted one class of share”.
Ventura and SMTB were then informed that their preference shares had been converted to ordinary shares, which triggered a claim to be submitted and the case to then be heard by the High Court.
Ventura claimed that the conversion of the preferred shares to ordinary shares was invalid, as the conversion of the preference shares amounted to a "variation or abrogation" of the special rights attached to such shares and was ineffective as no consent had been given to the conversion and thus did not accord with Article 10.1.
Ventura also claimed that the Court may also exercise its discretion under section 633 of the Companies Act 2006 (“CA 2006”) (which gives a court the power to set aside a variation of class rights) to not permit the “variation or abrogation” of the preference shares as this would unfairly prejudice Ventura and SMTB as holders of the preference shares.
The Company argued there was no “variation or abrogation” of any rights of the preference shares as the preference shares were simply exchanged, or swapped, for ordinary shares, which meant that Article 10.1 did not apply. The Company also stated that the evolution of the rights attached to the preference shares may in turn affect the enjoyment of such rights, but this does not constitute a variation of the rights, and that the conversion of the preference shares into ordinary shares was a risk that was “baked into” the preference shares on issue, and as such formed part of the rights that were acquired by Ventura and SMTB as a result of their investment in the Company.
With regard to section 633 of the CA 2006, the Company contended that Ventura had not made out any ground of unfair prejudice, and that there can only be a claim for unfair prejudice by a variation of class rights if the variation is undertaken in accordance with the CA 2006, rather than relating to a bespoke provision in the Company’s Articles.
There was a clear conflict between Article 9.2 and Article 10.1 in the Company’s Articles, and a mistake in not expressly stating that Article 9.2 was subject to Article 10.1 in taking into account “business efficacy, and integrity, to the articles as a whole”.
Upon reviewing the Company’s SHO1 at Companies House, any reader of the articles and the SH01 filed would note that Ventura and SMTB had paid a substantial premium for the special rights attached to the preference shares, and that the far greater number of ordinary shareholders in the Company had “inferior rights” to Ventura and SMTB as holders of the preference shares. Also, although a reader would note that neither Article 9 or Article 10 of the Company’s Articles addressed the question of whether the conversion of preferred shares is to be treated as constituting a “variation or abrogation” of rights, it was necessary to “ look at the reality of the situation”. It was therefore held that by converting the preference shares into ordinary shares, the special rights that were attached to the preference shares no longer exist, as there are no longer any preference shares in issue.
Although the Court held that the conversion of preferred shares into ordinary shares was “invalid, void and of no effect” by virtue of the Articles, it was noted that no claim for relief under section 633 by way of unfair prejudice would have been granted to Ventura, but that this did not affect the outcome of Ventura and SMTB’s claim.
When looking to invest in a company, or indeed when a company is seeking investment, it is essential that investment rights are scrutinised in the investment documentation to ensure that the deal terms that are envisaged are drafted into the documentation accordingly, and that there is no conflict between the provisions of the articles of association.
The case judgment can be found here.
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