Companies (Jersey) Law 1991: proposed amendments – Green Paper – Supplemental Response Paper.

STATES OF JERSEY

COMPANIES (JERSEY) LAW 1991: PROPOSED AMENDMENTS – GREEN PAPER –

SUPPLEMENTAL RESPONSE PAPER

Presented to the States on 24th December 2013 by the Chief Minister

STATES GREFFE

2013   Price code: B  R.158

Chief Minister's Department

Supplemental Response Paper

 Green Paper dated 25th November 2011 proposing  17th December 2013 amendments to the Companies (Jersey) Law 1991:

 Proposed amendments 3, 24 and 25

SUMMARY OF CONSULTATION

On 25th November 2011 the Minister for Economic Development ("the Minister") published a Green Paper inviting comments on 34 separate proposals for amendments to the Companies (Jersey) Law 1991 ("the Law"), including –

1. An amendment to Article 17, which provides that a private company with more  than  30 members  shall  be  treated  as  if it  were  a  public  company (proposed amendment 3).
2. An amendment to the definition of a distribution' contained in Article 114, so as to make it clear that any transaction between a company and its members which does not reduce the net assets of the company falls outside its scope (proposed amendment 24).
3. The introduction of a procedure for the ratification of distributions made in contravention  of  the  procedure  set  out  in Article 115,  which  requires  the directors  of  the  company  authorising  the  distribution  to make  a  solvency statement (proposed amendment 25).

The  Minister  published  a  summary  of  the  responses  to  the  consultation  on 5th February 2013. In relation to proposed amendment 3, the response paper stated that  it  had  been  decided  to  abolish  the  30 member  limit  for  a  private  company altogether.

In relation to proposed amendments 24 and 25, the response paper noted that the responses received had raised a number of issues. These required further reflection and consultation before a final decision was made whether, and in what way, to proceed with those proposed amendments.

Following the publication of the response paper, the Minister embarked on further consultation with interested parties in relation to amendments 24 and 25. The scope of this  consultation  was  subsequently  extended  to  include  certain  issues  arising  in connection with proposed amendment 3, which were raised by the Jersey Financial Services Commission ("JFSC") after publication of the response paper.

Further written representations were received from two of the major law firms in Jersey (Mourant Ozannes and Carey Olsen) and further advice was also sought from its external advisers (a practising UK barrister and a Professor of Law and Finance at the University of Oxford).

This  supplemental  paper  summarises  the  responses  received  during  the  further consultation. As responsibility for the Law passed to the Chief Minister during the course of 2013, this paper sets out the Chief Minister's final position in respect of each of the three amendments.

Calculation  of  number  of  members  for  change  of  status  to  public  company (Article 17A) (Proposed amendment 3)

As  set  out  above,  the  conclusion  reached  by  the  Minister  following  the  initial consultation  was  that  the  30 member  limit  for  private  companies  imposed  by Article 17 no longer served any useful purpose and that it could therefore safely be abolished.

However, the JFSC subsequently pointed out that the removal of the 30 member limit would mean that private Jersey companies whose securities are admitted to trade on a market outside the European Union would no longer be treated as public companies by the Law. It was said that this would be undesirable, in that it would reduce Jersey's compliance  with  the  International  Organisation  of  Securities  Commissions' (IOSCO's)  Objectives  and  Principles  of  Securities  Regulation  (in  particular Principles 16–21 relating to the disclosure of information to investors, provision of audited financial statements, accounting and auditing standards and the supervision of auditors).

The JFSC suggested that this issue could be addressed by making a further amendment to Article 17, to provide that any private company whose securities are admitted to trade on a regulated market outside the European Union, would also be subject to the Law as if it were a public company, or alternatively by amending the definition of a regulated market' contained in Article 102(1) so that it also applies to regulated markets outside the European Union. It requested, however, that any such amendment be delayed, pending completion of a more general review of Jersey's compliance with the IOSCO Principles, which it intends to undertake in the course of 2013.

Responses

One of the written responses received expressed concern about the suggestion that the definition of regulated market' be amended so as to extend to markets outside the European  Union.  It  pointed  out  that  this  would  seem  to  require  Jersey  private companies listed on such an exchange to appoint a Jersey or UK auditor rather than a local auditor who would be much better placed to audit the company.

The other written response agreed with this view and expressed the opinion that it would be better to leave Article 17 unamended. It pointed out that one of the original reasons for the abolition of the 30 member limit arose out of uncertainty over whether the UK Takeover Code would apply to a Jersey private company simply by virtue of the fact that it had more than 30 members and was therefore subject to the Law as if it were a public company. Recent experience, however, suggests that the Takeover Panel does not consider that the Code would apply in such circumstances.

The responses also suggested that it would be sensible to amend the Law so that the 30 member limit could in future be abolished or amended by means of Regulations passed  by  the  States.  It  was  also  suggested  that in  any  event,  an  amendment  to Article 17A of the Law to extend the scope of that provision to current and former directors and employees of subsidiaries and of other companies in the same group, should be made. This was one of the other options outlined in the original Green Paper.

Chief Minister's position

It is recognised that there is a risk that the abolition of the 30 member limit might adversely affect Jersey's compliance with IOSCO Principles. As has been suggested, it may be that this risk could be eliminated by making further amendments aimed at ensuring that companies whose securities are traded outside the EU continue to be treated as public companies. However, it is clear from the responses received that such amendments could themselves have undesirable consequences, and therefore require careful consideration.

In light of this, and of the fact that one of the original reasons behind the proposed amendment appears to have fallen away, it has been decided not to proceed with the abolition of the 30 member limit at present. This matter is intended to be reconsidered once the JFSC has concluded its own review.

It has, however, been decided to introduce a provision into the Law enabling the States to abolish or amend the 30 member limit by Regulations.

Furthermore, the Chief Minister will also proceed with the proposed amendment to Article 17A, so that, in determining whether a company has more than 30 members for the purposes of Articles 16 and 17(2), no account is to be taken of members of the company who are current or former directors or employees of the company, any subsidiary of the company, or any other company in the same group of companies.

The scope of the term distribution' (Article 114(2)) (Proposed amendment 24)

As described in the Green Paper, this amendment arose out of a concern amongst practitioners that certain bona fide commercial transactions between a company and its members  might  unintentionally  be  caught  by  the  very  wide  definition  of  a distribution' contained in Article 114, and might therefore be potentially rendered unlawful because the solvency statement procedure set out in Article 115 had not been followed.

The example given in the Green Paper was that of an upstream guarantee, given by a subsidiary to a third party in respect of indebtedness of its parent. Unless there is a probability that it would be called upon, so that it would have to be recognised immediately as a liability in the subsidiary's accounts, the giving of such a guarantee would not affect the net asset position of the company and therefore ought not to be treated as a distribution.

Following the close of the initial consultation, the Minister remained unpersuaded that the proposed amendment was in fact necessary. On the current state of the Law, the risk that a genuine commercial transaction between a parent and its subsidiary, such as the giving of an upstream guarantee, would be treated as a disguised distribution within the meaning of Article 114(1), appears to be negligible.

Furthermore,  as  noted  in  the  response  paper,  concerns  were  expressed  that  the proposed  amendment  might  have  the  effect  of  creating,  rather  than  eliminating, uncertainty over whether certain types of transaction are caught be the definition. It might be argued that the amendment demonstrates that the Jersey legislature intended to include in the definition of a distribution' a wide range of transactions between a company and its members, which do reduce the company's net assets. By focusing on the net asset position of the company before and after the transaction, the proposed amendment could prompt the Jersey courts to adopt a stricter approach than that adopted by the English courts, which is to treat a transaction between a company and its members as a disguised distribution only if it is at a gross undervalue which cannot be justified in commercial terms. This approach allows a wide margin of appreciation (see the decision of the UK Supreme Court in Progress Property Co Ltd. v Moorgarth Group Ltd. [2010] 1 WLR 1, which is of persuasive authority in Jersey).

In the course of further consultation with interested parties following the publication of the response paper, it was strongly argued that, given the sums of money that can be involved  in  the  transactions  under  consideration,  the  proposed  amendment  was necessary to eliminate any risk, however small, of them being subsequently found to be unlawful.

It further emerged that a related problem potentially arises in connection with intra- group transfers of assets at book value, which had not been raised in the Green Paper. Where the book value of the assets is significantly below their market value, there may be a risk that the transaction could be characterised as a disguised distribution, even though there is no reduction in the company's net assets. In the UK this problem became known as the Aveling Barford' problem (after Aveling Barford v Perion Ltd. [1989] BCLC 626) and was addressed by the introduction of the statutory provisions now contained in section 845 of the Companies Act 2006.

In response to the issues raised it was proposed, as an alternative solution, that the definition of a distribution' in Article 114 be left as it is, but that Article 115 be amended so as to provide that its requirements do not apply to a distribution which does not reduce the net assets of the company. It was considered that this approach would achieve the objectives of the original proposal, whilst at the same time avoiding the  unintended  consequences  that  might  flow  from  amending  the  definition  of  a distribution' itself.

Responses

Both of the written responses received during the further consultation supported this solution.

Chief Minister's position

Accordingly, the Chief Minister now intends to proceed with the alternative solution outlined above.

Ability to ratify a distribution (Article 115) (Proposed amendment 25)

The requirement laid down in Article 115 that the directors of a company make a solvency statement prior to authorising any distribution of the company's assets to its members exists for the protection of the company's creditors. However, as described in the Green Paper, many practitioners consider that this requirement has created a trap for the unwary'. There is anecdotal evidence to suggest that the requirement for a solvency statement is sometimes overlooked.

In addition, it occasionally happens that a transaction between a company and its members subsequently has to be re-characterised as a distribution. If no solvency statement was made (as is likely) prior to the transaction, it would be an unlawful distribution.

The consequences of making an unlawful distribution are serious. The directors who authorised the distribution may be personally liable to restore to the company the amount  of  the  distribution.  Furthermore,  under  Article 115A,  shareholders  who received an unlawful distribution can also be liable to repay it (or pay the company an amount equivalent to the value of the distribution if it was made otherwise than in cash) if they knew or had reasonable grounds for believing that the distribution was unlawful.

As  matters  stand,  the  Law  does  not  provide  a  mechanism  whereby  an  unlawful distribution can be validated or ratified retrospectively. It is understood that there is a legal solution to this problem, however, it is understood that this solution is far from perfect and is not always suitable in the circumstances.

The original proposal set out in the consultation paper envisaged that the directors would  be  permitted  to  ratify  an  unlawful  distribution  by  making  a  retrospective solvency statement. Concern was expressed, however, that this would undermine the significance of the requirement for a prior solvency statement, and thereby dilute creditor protection. In effect, such a statement would no longer be a pre-condition of validity for a distribution.

The point of making the validity of a distribution conditional upon the making of a solvency statement is to ensure that the directors address their minds properly to the financial position of the company before they pay away the company's money. By permitting solvency statements to be made retrospectively, the proposed amendment risks increasing the chances of a distribution being made at a time when the company is  in  fact  insolvent.  Although  the  original  proposal  does  not  envisage  that  the retrospective procedure would be available in such circumstances, creditors of the company may nevertheless still be prejudiced, as they would be left having to pursue remedies against the directors and/or shareholders (many of whom may be resident in other jurisdictions).

The Minister indicated in the response paper that he was sympathetic to the argument that the legislation in its current form created an unnecessary trap for the unwary', and that it agreed in principle that there should be a procedure for retrospectively validating a distribution made in contravention of Article 115, subject to appropriate safeguards. Further reflection and consultation was, however, considered desirable before a decision was made as to how best to achieve this.

In the course of the further consultation that took place after the publication of the response  paper,  interested  parties  were  invited  to  comment  on  two  alternative solutions. The first of these involved a court-based procedure akin to that found in Article 6 of the Limited Liability Partnerships (Jersey) Law 1997 (as amended by the Limited  Liability  Partnerships  (Amendment  of  Law)  (Jersey)  Regulations  2013). Pursuant to such a procedure, the company would have to make an application to the Royal Court for an order that retrospectively validates the distribution and relieves the directors and shareholders from any liability to repay it.

It was envisaged that, as a pre-condition to the making of such an order, the Royal Court would have to be satisfied as to the solvency of the company both at the date of the hearing and at the date on which the distribution was made, and, if the distribution was made less than 12 months prior to the hearing, that the company was likely to remain solvent for the remainder of that period.

The other alternative proposed was a procedure modelled on that in Parts 18B and 18C of the Law, which deal with mergers of companies and continuance outside Jersey. In broad outline, such a procedure would require the company to notify its creditors of the making of a retrospective solvency statement. Upon receiving such notification, the onus would then be on the creditors of the company to make an application to court within a specified period of time (say 21 days) for an order setting aside the retrospective solvency statement, e.g. that the company was not solvent at the time of the distribution, or that there is some other reason why it would be contrary to the interests of justice for the directors and/or shareholders to be relieved of liability to repay the distribution.

Responses

Both  of  the  written  responses  received  expressed  concerns  that  these  alternative options  were  unnecessarily  onerous.  They  reiterated  a  preference  for  the  original proposal set out in the Green Paper. One of the responses stated that, if the original proposal was no longer acceptable, both alternatives should be made available. This response also suggested that the court-based procedure should not be subject to a solvency requirement (at least not a solvency requirement at the time the unlawful distribution was made).

The  other  response  suggested  that  the  concerns  raised  in  relation  to  the  original proposal might be overcome by requiring that a solvency statement made in respect of an earlier, unlawful distribution be prospective, i.e. the directors would have to state their belief that the company would remain solvent and continue to be able to carry on its business for a period of 12 months from the date of the new statement.

Chief Minster's position

The Chief Minister has carefully considered these responses. It has been decided not to proceed by drafting an amendment in the form originally proposed in the Green Paper. The reasons for this are as follows.

First, the effect of the amendment in its original form would be to permit the directors of a company to self-ratify' a breach of their statutory duty without appropriate scrutiny. As a matter of principle, this seems anomalous.

Second, it has not been established that the amendment as proposed in the Green Paper does not carry with it a real risk of weakening creditor protection, and a related risk of reputational damage for Jersey as a jurisdiction.

In  this  regard,  it  is  noted  in  passing  that  no  other  jurisdiction  which  requires  a solvency statement as a pre-condition for the validity of a distribution by a company to its members, appears to have adopted the approach envisaged by the original proposal. Indeed,  one  such  jurisdiction  (New  Zealand)  imposes  criminal,  as  well  as  civil, liability for a failure to make the required statement prior to authorising a distribution.

Finally, the amendment in its original form would create a disparity between the rules applicable to companies and the rules applicable to LLPs, which were revised only very recently. Partners in an LLP would be subject to a more onerous regime for validating unlawful distributions than the directors of a company. There do not appear to be any good reasons why this should be so. Concerns about creditor protection apply to companies and LLPs with equal force.

In order to address the problem that was identified in the Green Paper, it has been decided  to  introduce  into  Part 17  of  the  Law  a  court-based  procedure  for  the ratification of distributions made in contravention of Article 115. The advantage of such a procedure is that it provides an element of scrutiny, which is absent from the original proposal.

Furthermore,  although  there  has  never  been  anything  to  suggest  that  directors authorise unlawful distributions as a matter of course, if further incentive were needed to remind directors of this particular requirement of the Jersey Law, the need for a court  procedure  to  ratify  an  unlawful  distribution  might  go  some  way  towards providing it.

The  new  procedure  will  allow  a  company,  which  has  made  a  distribution  in contravention of Article 115, to make an application to the court for an order that a distribution  shall  be  deemed  for  all  purposes  to  have  been  lawfully  made, notwithstanding the fact that it was made in contravention of Article 115.

The threshold conditions for the making of such an order should be as follows –

1. At the time of the hearing of the application the company is able to discharge its liabilities as they fall due; and
2. the company was able to discharge its liabilities as they fell due immediately following the date on which the distribution was made; and
3. if the distribution was made less than 12 months prior to the hearing, there are reasonable grounds for believing that the company will continue to be able to discharge its liabilities as they fall due and carry on its business until the expiry of a period of 12 months from the date on which the distribution was made.

It is envisaged that, in cases where the solvency of the company is not in any doubt, and it is clear that the failure to make a solvency statement was an innocent oversight by the directors, an order should generally be made as a matter of course. Accordingly, the new provisions will be worded in mandatory terms requiring the court to make an

order if the threshold conditions are satisfied, unless it considers for some other reason that it would be contrary to the interests of justice to do so.

There is a concern to ensure that the new procedure is not unnecessarily onerous. Accordingly, it is envisaged that an application for an order ratifying an unlawful distribution may, unless the court orders otherwise, be made without notice to any other person (such as the company's creditors).

It is considered that it would be undesirable for the new provisions to prescribe the circumstances in which the court ought to order that notice of the application be given to any other person. This will depend entirely on the particular facts and circumstances of the case, and it is therefore best left to the good sense of the judge dealing with the application. In considering this issue the court may, for instance, find it helpful to have regard to the practice developed in relation to applications under Articles 62–63 of the Law for confirmation of a reduction of capital.