Court of Appeal confirms application of Duomatic principle to beneficial shareholders

In a recent decision, the Court of Appeal has followed last year’s Privy Council decision in Ciban Management Corpn v Citco (BVI) Ltd [2020] UKPC 21 (noted here) and confirmed that the Duomatic principle applies to beneficial shareholders, provided they are taking all of the decisions in the relevant transaction: Satyam Enterprises Ltd v Burton [2021] EWCA Civ 287.

The Duomatic principle allows shareholders of a solvent company to take any decision by informal, unanimous and informed consent, if that decision could also have been taken formally in general meeting or by way of written resolution. Disputes as to the application of the Duomatic principle often arise in the context of an alleged breach of duty by a company’s directors, where the directors may contend that such breach was approved or ratified by shareholders.

There was previously some uncertainty about whether shareholder consent should be assessed by reference to the legal owners of the shares (ie those recorded on the company’s register of members, who would be entitled to participate in a general meeting or a written resolution procedure) or, if different, the beneficial owners. In this decision the Court of Appeal has confirmed that, at least where the beneficial owner is taking all of the relevant decisions in the relevant transactions, the test is whether that beneficial owner gave its consent.

However, the Court of Appeal remitted the case to the High Court to determine whether the transaction, involving the transfer of property out of the company, constituted an unlawful return of capital. If it did, the transaction was not capable of being approved or ratified by shareholders, whether formally or informally.

Background

The claim concerned four properties in Croydon (the “Properties”) which were bought at auction in May 2012 by Mr Vidya Sharma (“Mr Sharma”). At completion, Mr Sharma arranged for the Properties to be acquired by a company called JVB Five Properties Limited (“JVB5”), of which the sole legal shareholder and director was Mr John Burton (“Mr Burton”). The total cost of the purchase was £1,137,000.

In October 2012, JVB5 (acting by Mr Burton) transferred the Properties to another of Mr Burton’s companies, JVB7, recording a price of £2,230,000 but without any money changing hands. During the course of 2013, JVB7 (again acting by Mr Burton) sold all of the Properties for £1,865,000 save for a studio flat, which was transferred for nil consideration to a third party.

JVB5, now called Satyam Enterprises Ltd, brought a claim against Mr Burton for breach of his duties as its director when transferring the Properties to JVB7 at what was said to be a significant undervalue. The true value was alleged to have been £1,660,000 but JVB7 had not in fact paid any money in consideration for the transfer of the Properties.

Mr Burton denied that the Properties were transferred at an undervalue. He also asserted that, at the time of the transfer from JVB5 to JVB7, he held all of the issued share capital in those companies on trust for Mr Sharma and that the transfer had been carried out at his direction. Accordingly, as the transfer had been expressly authorised by JVB5’s sole beneficial shareholder, the Duomatic principle applied.

At first instance, the deputy judge dismissed JVB5’s claim, including because he accepted Mr Burton’s submission that the Duomatic principle applied.

JVB5 appealed, including on the ground that the deputy judge was wrong to find that the Duomatic principle applied to ratify or absolve Mr Burton from his breach of duty. JVB5 put forward three separate arguments in support of this ground of appeal:

• The transaction could not be ratified by shareholders because it amounted to an unlawful distribution of JVB5’s assets.
• There had not been any outward manifestation of Mr Sharma’s alleged informal consent.
• The transaction could not be ratified as it was part of an intended scheme to misrepresent the true purchase price of the Properties to potential lenders.

Decision

The Court of Appeal allowed the appeal and remitted to the High Court the question of whether the transfer amounted to an unlawful return of capital such that it could not be ratified under the Duomatic principle. Nugee LJ gave the leading judgment, with which Lewison and Arnold LJJ agreed.

Dealing first with the application of the Duomatic principle to beneficial shareholders, the court applied Ciban: where the beneficial owner of shares is taking all of the decisions in relation to the relevant transaction, the principle applies as regards the consent of (and authority given by) the beneficial owner of the shares, not the legal owner.

The Court of Appeal rejected the second and third of JVB5’s arguments. In relation to the outward manifestation of Mr Sharma’s consent, the Court of Appeal was prepared to assume without detailed argument that this was a requirement of the Duomatic principle and that it was not enough for Mr Sharma’s consent to have been given “in his private thoughts”. However, on the facts of this case, Mr Sharma had sent an email which confirmed his agreement to Mr Burton transferring the properties from JVB5 to JVB7, so the issue did not arise.

As to the argument that a transaction infected by fraud could never be ratified, the Court of Appeal accepted Mr Burton’s submission that any dishonesty on the part of Mr Burton was not directed at JVB5. The Duomatic principle is intended to deal with the authorisation of transactions by the company, not protect third parties from dishonest acts of a company’s directors.

However, in relation to JVB5’s first argument, the Court of Appeal accepted that a limited company which is not in liquidation cannot lawfully return capital to its shareholders except by way of a reduction of capital approved by the court. Profits can be distributed but only out of distributable profits in accordance with the Companies Act 2006. Shareholders cannot authorise an unlawful distribution because it is ultra vires the company. The Duomatic principle cannot be relied on by the shareholders of a company to allow them to authorise informally what could not have been authorised formally.

As the deputy judge had not made sufficient findings of fact to allow proper consideration of whether the transaction amounted to an unlawful distribution, the case was remitted to the High Court for further hearing on that point.