Re Liberty International Plc

In March 2010 Liberty International PLC (“Liberty”) announced its intention to separate its two businesses. One of those businesses is focused upon central London property investment and development activities (both independently and as a participant in joint ventures) but also involves investments in China. The other business is conducted through a wholly owned subsidiary which develops, owns and manages prime regional shopping centres (including 9 of the top 30 regional centres).

The board of Liberty has decided that these are distinct businesses with different risk and reward profiles and differing capital requirements. It has therefore decided to demerge the property investment and development business. The demerger has been structured in a conventional manner as a reduction of capital involving a return of capital to members which is satisfied by the issue of new shares in a new company to which the assets which would otherwise be returned to members will have been transferred. The new company is to be called Capital & Counties Properties PLC (“Capco”).

The return of capital is achieved by the cancellation of the share premium account standing in Liberty’s balance sheet at just over £1 bn and the issue to each holder of a Liberty share of one new share in Capco. The net asset value of the assets comprising the Capco business is estimated at £730.9 million, though this, of course, may fluctuate up to the effective date. The size of the proposed cancellation exceeds that, but will lead to the creation of a reserve sufficiently large to support the demerger.

I am satisfied:-

The proposed reduction is straight forward, and the sanction of the court would ordinarily have been given by Mr Registrar Nicholls (who considered the matter in detail). It has come before me because of issues relating to timetabling and to creditor protection.

Liberty is listed on the London Stock Exchange, with an independent secondary listing on the Johannesburg Stock Exchange. In order that Liberty shareholders will not be disadvantaged by the demerger, it is proposed that the same arrangement will obtain in relation to the new Capco shares. The requirements of the Johannesburg Stock Exchange are more rigid than those in London (and Johannesburg also has a longer settlement period). This results in a longer period than usual elapsing between the court sanctioning the cancellation of the share premium account (thereby enabling the demerger) and the commencement of dealings in Capco shares. This restraint upon the marketability of the Capco shares would be a disadvantage to Liberty shareholders. But arrangements had been made for dealings in Capco shares to commence on the London Exchange on 10 May 2010 on a “when issued basis” i.e. the dealings will be entered into before, and conditional upon, the application for the listing and trading of the Capco shares becoming effective on 17 May 2010. I am satisfied with these arrangements (the relevant risks attaching to which are spelt out in the circular to Liberty shareholders).

I turn to the creditor issues. Where capital is reduced the court is always concerned to see that the position of creditors is safeguarded. The precise nature of the safeguard which will satisfy the court has evolved over time: but the range of possibilities is well settled. However, the nature of the safeguarding exercise itself has been altered by the Companies Act 2006.

A private company limited by shares may now (by section 642 CA 2006) reduce its share capital if the resolution for reduction is supported by a solvency statement complying with section 643. This requires each of the subscribing directors to have formed the opinion that at the date of the statement there is no ground upon which the company could then be found to be unable to pay its debts; and also to have formed the opinion that the company will be able to pay or otherwise discharge its debts in full in the year next following. The sanction of the court is thus not required.

For other companies, however, the sanction of the court is still required. Section 648(2) CA 2006 says that the court must not confirm a reduction of capital unless it is satisfied “with respect to every creditor of the company who is entitled to object to the reduction of capital” that either:-

The class is now identified in section 646(1) CA 2006. This provides:-

“Every creditor of the company who

(a)

at the date fixed by the court is entitled to any debt or claim that, if that date were the commencement of the winding up of the company would be admissible in proof against the company, and

(b)

can show that there is a real likelihood that the reduction would result in the company being unable to discharge his debt or claim when it fell due

is entitled to object to the reduction of capital…”.

Section 646(1) (b) derives from words first introduced by SI 2008/719 and taking effect from 6 April 2008.

Entitlement to object therefore depends upon satisfying two conditions. First, entitlement to a debt that would be admissible in proof at the relevant date. Second, proof by the creditor that there is a real likelihood that the reduction itself would result in the company being unable to discharge the debt when it falls due.

An issue arises whether certain claims that might arise in certain contingences constitute claims that would be “admissible in proof” at the relevant date. Earls Court and Olympia Limited, Earls Court Limited and Olympia Limited (“the ECO companies”) are indirect, wholly owned sub-subsidiaries of Liberty. The entire issued share capital of their intermediate holding company will be transferred to Capco as part of the demerger. The ECO companies are participating employers in relation to a pension scheme (“the ECO Scheme”). The ECO Scheme has a deficit of about £1.9 million on an ongoing funding basis, and £3.4 million on an accounting basis. Because Liberty is the ultimate controlling company of the ECO companies prior to the demerger there is the possibility that it could be called upon to contribute to that deficit (even though the trustees of the ECO Scheme have no direct claim against Liberty).

Under section 38(2) of the Pensions Act 2004 the Regulator may issue a notice “stating that the [addressee] is under a liability to pay a sum specified in the notice” to the trustees of an occupational pension scheme or to the Payment Protection Fund. Such a contribution notice can only be issued if the Regulator is of the opinion (i) that the addressee was a party to a wrongful act of a specified nature or (ii) that the addressee was party to an act or failure that detrimentally affected in a material way the likelihood of scheme benefits being received and (iii) that it is reasonable to impose liability in the sum stated. The evidence establishes that (so far as is known) exposure to a contribution notice is an entirely theoretical possibility. By section 43(2) of the Pensions Act 2004 the Regulator may also issue “a financial support direction” if the Regulator is of the opinion that the employer in relation to the ECO Scheme (one of the ECO companies) is insufficiently resourced. As the ultimate holding company of the ECO companies immediately prior to the demerger, Liberty is theoretically exposed to a financial support direction being made in the future. If it were made, and if Liberty did not comply or secure compliance with it then under section 47(2) of the Pensions Act 2004 the Regulator may issue a notice to Liberty stating that it is “under a liability to pay to the trustees or managers of the Scheme the sum specified in the notice”. What account (if any) must be taken of these theoretical pension claims when considering who are the creditors “entitled to object” to the cancellation of the share premium account (and so whose claims must be discharged or secured in the absence of their consent)?

In my judgment none. These claims are not “admissible in proof”. There is a well settled line of authority which establishes that where the imposition of the obligation under which the debtor is made liable depends upon the exercise of some prior discretion (which has not itself been exercised at the relevant date) then at the relevant date the debtor is not subject to any liability (future, contingent or otherwise): see Glenister v Rowe [2000] Ch 76, Steele v Birmingham City Council [2006] 1 WLR 2380 and Casson v Law Society [2010] BPIR 49. Liberty is not at present liable to the trustees of the ECO Scheme or to the Pension Protection Fund: it can only become liable if the Pension Regulator exercises his discretion to make either a contribution notice or a financial support direction (followed by a contribution notice). The claims are therefore not at present “admissible in proof”.

Claims which are admissible in proof include future claims (i.e. claims not presently due but which are certain to accrue due in the future) and contingent claims (i.e. where under an existing obligation Liberty may or will become subject to a present liability on the happening of some future event). But a present, future or contingent creditor cannot object to a reduction in the company’s capital simply because he is such: he must demonstrate that “there is a real likelihood that the reduction would result in the company being unable to discharge his debt…when it fell due”.

The test imposed by the statute is “a real likelihood”, and it is undesirable to put any gloss upon those words. But equally it is unhelpful simply to say that I share the view of Mr Registrar Nicholls that, having regard to the terms of the intended demerger in the instant case, no creditor could satisfy that test and accordingly a list of creditors was properly dispensed with.

Where the section calls upon a creditor to show “a real likelihood” that the reduction “would” result in an inability to discharge the debt when it becomes due, it is calling upon the creditor to demonstrate a particular present assessment about a future state of affairs. In considering the evidence I identified three elements: what follows is descriptive of the course I followed, not prescriptive as a course to be adopted by others.

First, I looked at the factual: whatever assessment is made has to be well grounded in the facts as they are now known. Although one is looking to the future one has to avoid the purely speculative.

Second, there is a temporal element. One is looking forward for a period in relation to which it is sensible to make predictions. That period will, of course, be affected by the nature and duration of the liability in question. So a continuing direct liability under a lease may indicate that a correspondingly long term view must be taken. But in general the more remote in time the contemplated event that will make payment fall due the more difficult it must be to establish the reality of the likelihood that the return of capital will itself result in inability to discharge the debt. For private companies directors are required to look forward for twelve months. I do not suggest that implicitly the same period applies where the sanction of the court is necessary: but I do consider that in any given case there will be a natural temporal boundary beyond which sensible assessment of likelihood is not possible.

Third, the section obviously does not require a creditor to prove that a future event will happen: it is concerned to evaluate the chance of the event (the company’s inability to discharge the debt because it has returned capital). It describes the chance as “real likelihood”, thereby requiring the objecting creditor to go some way up the probability scale, beyond the merely possible, but short of the probable. That is the “degree of persuasion” (as it was put by Hoffman J in re Harris Simons Construction Limited [1989] BCLC 202 at 204 F to H) for which I have looked in assessing the evidence.

In the instant case the aggregate of debts and claims which would be admissible in proof against Liberty at the last practicable date before the preparation of the evidence amounted to some £438 million. The creditors who consented in writing to the proposed cancellation of the share premium account amounted to some £298.5 million (consisting of the providers of the company’s revolving credit facility, creditors under intra-group balances and counter parties under interest rate and cross currency swap agreements, none of whom agreed to subordinate their claims). There are bond holders with claims in the immediate future worth some £80.7 million (in respect of whom the company has deposited in a trust account for their benefit a cash amount equal to their aggregate claims) whose claims are fully secured. There is then a body of non-assenting creditors. To gauge what might be necessary for their protection the company has prepared a Working Capital Model addressing the claims of both assenting and non-assenting creditors up until December 2011. According to this model (which of course can only predict and cannot guarantee future outcomes) the company should have at least £90 million of available working capital at the end of each quarter up until the fourth quarter of 2011, and presently forecast net assets of £1.845 billion for the calendar year ending 2011. There is thus a credible foundation in the evidence to support a current assessment that the company has sufficient working capital for its present requirements and for at least eighteen months following the date of the proposed demerger. On this basis the directors of the company expressed the view that none of the creditors would be able to show that there is a real likelihood that the proposed cancellation of the share premium account would result in the company being unable to discharge their debts when they fall due. I accept that evidence and I agree with the conclusion drawn.

As I have indicated, Mr Registrar Nicholls in fact dispensed with the requirement for the settlement of a list of creditors. The matter was raised before me not by way of appeal or review, but rather because Mr Martin Moore QC considered that, in discharge of his duty to the court on such an application, the matter ought specifically to be drawn to my attention before I was invited to sanction the cancellation. That was undoubtedly the right course to take: but I intend to make an order confirming the cancellation of the share premium account and approving the statement of capital in the form sought.

For these reasons I confirmed the reduction of Liberty’s capital.

But a further point then arose in relation to Capco. The value of the assets being transferred to Capco was of the order of £1.17 per new share to be issued. But the nominal value of each share was £0.80. So there was an effective premium of £0.37 per share. Capco itself was to undertake a reduction of capital, and in that connection s.649 CA 2006 requires me to approve a Statement of Capital for Capco. The question that arises is how that effective premium of £0.37 should be treated in a Statement of Capital that I can approve.

By section 649(2)(d) CA 2006 the Statement of Capital must state with respect to the company’s share capital as altered by my order “the amount paid up…..on each share (whether on account of the nominal value of the share or by way of premium)”. The purpose of this statement is to inform creditors about the aggregate value of the share capital (the funds that cannot be handed back or distributed to shareholders) and the extent to which it can be increased by calls.

In principle, a premium paid upon the issue of a share does not form part of a company’s capital but is capable of distribution amongst the members. That was established in Drown v British Picture Corporation Ltd [1937] Ch 403. In that case a shareholder sought an injunction to restrain the payment of a dividend on the ground that it could only be paid out of capital. The shares of the company had from time to time being issued at a premium which was always carried to a reserve. It was out of this reserve that the dividend was to be paid. Clauson J held:-

“The premium from its very nature is not part of the capital paid upon the shares; it is the surplus of the sum received in respect of the share over the amount required to pay up the share to the extent to which it is treated by the company as paid up. The capital paid up on the share must not be divided in dividend: but the premium is not capital paid up on the share but a sum received by the company in excess of the capital paid up on the share: and the principle that capital paid up on the share must not be divided in dividend is in no way infringed by distributing a premium in dividend.”

(Whether it is actually available for distribution is a different question: I am addressing only the principle).

This principle has been altered by statute. By s. 610 CA 2006, if a company issue shares at a premium then a sum equal to the aggregate amount or value of the premiums must be transferred to an account called “the share premium account”. By s. 610(3) the company may use that share premium account to issue fully paid bonus shares: but otherwise, for the purposes of the provisions relating to reduction of capital the share premium account is treated as if it was part of the paid-up share capital of the company.

However, s. 610 CA 2006 does not apply where shares are issued at a premium in the circumstances defined in s. 612 CA 2006 (which is headed “merger relief”). S. 612(2) provides:-

“ If the equity shares in the issuing company allotted in pursuance of the arrangement in consideration for the…. cancellation of equity shares in the other company are issued at a premium, section 610 does not apply to the premiums on those shares..”

The aggregate value of those premiums is carried to “a merger reserve” as an unrealised profit, and the principle established in Drown applies to that reserve. If the unrealised profit is realised then it will become distributable.

So does a rateable part of the merger reserve have to be added to the amount shown as paid up on each share “by way of premium” for the purposes of the Statement of Capital in the Capco reduction? In my judgment it does not. The provisions of the Act relating to the attribution of the share premium account to individual shares are not without their difficulties. Their objective appears to be that it was considered that creditors would be interested in the aggregate value of the share premium account because (together with the paid-up element of the total nominal value of the issued shares) it constituted the undistributable capital of the company (see paragraphs 40 and 55 of the November 2009 Consultation on Financial Information undertaken by the Department for Business Innovation and Skills). But it is generally recognised that it is not always possible to attribute the total paid-up share premium between the shares currently in issue: and I would be loathe to distort the picture further by requiring the relevant computation to take into account not only undistributable capital but also unrealised profit ultimately capable of distribution (derived from the merger reserve). I see no reason to read the Act in a way that requires that to be done.

In my judgment where s.649(2)(d) requires the Statement of Capital to state the amount paid up on each share (whether on account of nominal value “or by way of premium”) it is requiring an attribution of a share premium account to which section 610 CA 2006 applies i.e. one that is treated as part of the share capital of the company for the purposes of the provisions relating to reduction. That is consistent with the declared function of the Statement of Capital which is that it should be “…essentially a “snapshot” of the company’s share capital…” (see paragraph 46 of the Explanatory Notes). It reflects the present understanding of the value of a Statement of Capital. It is an entirely sufficient implementation of Article 2 of the Second Company Law Directive (77/91/EC). It is in accordance with established principle. There are no grounds for preferring any other interpretation.

I have therefore approved a Statement of Capital which does not attribute the reserve arising on the demerger.