EIC Services Ltd. & Anor v Phipps & Ors

A bonus issue is void for common mistake where its resolution proceeds on the fundamental assumption that all shareholders will receive fully paid shares, but the directors lack authority to capitalise reserves and can issue only nil-paid shares. The defects must be assessed cumulatively. The court cannot preserve the issue for a minority of shareholders by severing the capitalisation and paying-up provisions.

A shareholder receiving a bonus issue is not a person dealing with the company for section 35A(1) of the Companies Act 1985. That provision therefore cannot validate an unauthorised internal bonus issue.

The company and its Guernsey parent sought a determination of the validity of a December 1999 issue of bonus shares. Master Moncaster directed preliminary issues. Neuberger J held that most pre-existing shares were unpaid and that the capitalisation and bonus issue lacked the ordinary resolution required by the articles. He nevertheless held that the shares were validly issued as nil-paid shares and that section 35A(1) of the Companies Act 1985 could in principle validate them as fully paid.

Mr Barber, a former shareholder, appealed. The central issues were whether the bonus issue was void for common mistake and whether section 35A(1) applied to shareholders who received bonus shares.

1. Appeal allowed unanimously. The court declared that the bonus issue of 15 December 1999 was void.

2. The bonus resolution contemplated one integrated transaction. It required a stated sum in the share premium account to be capitalised and appropriated so that every existing shareholder would receive 99 fully paid shares for each share held. Regulation 110 required the authority of an ordinary resolution before the directors could capitalise and appropriate the reserve. That authority was absent. Most existing shares were also unpaid, so their holders were not entitled to participate equally in a dividend-based appropriation.

3. The directors could issue nil-paid shares, but that was fundamentally different from the fully paid bonus shares contemplated and accepted. Applying the reasoning in Re Cleveland Trust plc [1991] BCLC 424, the relationship was sufficiently analogous to contract for common-mistake principles to apply. The defects were interlinked and falsified the fundamental assumption underlying the whole issue. The judge had erred by considering their effects separately and by treating the issue as capable of surviving for the minority of paid-up shares. Severance of the capitalisation and paying-up provisions would be impermissibly destructive of the intended resolution.

4. Section 35A(1) of the Companies Act 1985 did not validate the issue. A recipient of bonus shares was not, in ordinary language or statutory context, a person dealing with the company. A bonus issue is an internal rearrangement which does not alter the company’s assets or liabilities, alter proportionate holdings, or require shareholder action. Article 9(2) of the First Council Directive on Company Law, 68/151/EEC, which referred to third parties, supported that construction. Smith v Henniker-Major [2003] Ch 182 concerned different issues and did not assist.

5. It was therefore unnecessary to determine good faith or the further asserted limitations on the board’s powers under section 35A.

• Court of Appeal (Civil Division) In [2004] EWCA Civ 1069, Peter Gibson LJ gave the judgment, with which Sedley LJ and Newman J agreed. The appeal was allowed and the bonus issue was declared void.
• High Court of Justice, Chancery Division Neuberger J determined preliminary issues. He held that the bonus issue lacked the required member authority, but concluded that the shares were validly issued as nil-paid shares and that section 35A(1) of the Companies Act 1985 could in principle validate them.
• Master Moncaster Directed the trial of preliminary issues on 26 June 2002.