Progress Property Company Limited v Moorgarth Group Limited

A transaction between a company and its shareholder is not an unlawful return of capital merely because hindsight shows that it was commercially disadvantageous. Its character depends on its substance and purpose, assessed from all relevant circumstances. The parties’ description is not decisive and their state of mind may be relevant, but the inquiry is neither exclusively subjective nor a retrospective valuation exercise.

A genuine arm’s-length commercial transaction remains effective even if it proves to be a poor bargain. A transaction that is, in substance, a pretence for extracting value for a shareholder is an unlawful distribution. The settlement or release of a supposed independent liability is not automatically recategorised as a distribution merely because the directors were mistaken about that liability.

Progress Property Company Limited sold the shares in its wholly owned subsidiary, YMS Properties (No 1) Ltd, to Moorgarth Group Limited, a company within the same wider group. The appellant alleged that the sale price was a gross undervalue and therefore an unlawful return of capital to its shareholder.

For the appeal, it was assumed that the sale might have been at an undervalue and that a common director had failed to recognise this. It was common ground that he genuinely believed the transaction to be a commercial sale at market value. The Court of Appeal unanimously upheld the deputy judge’s dismissal of the claim: [2009] EWCA Civ 629; [2010] 1 BCLC 1. The central issue was whether the agreement was, in truth, an unlawful distribution of capital dressed up as a sale.

1. The appeal was unanimously dismissed. Lord Walker gave the leading judgment. Lord Mance agreed with its reasoning and conclusions. Lords Phillips and Collins agreed with both judgments, and Lord Clarke agreed that the sale was not an unlawful distribution of capital.
2. The Court held that the common-law maintenance-of-capital rule requires an inquiry into the true purpose and substance of the impugned transaction. Labels and outward form do not decide its character. The court must assess all relevant facts, which may include the state of mind of those directing the companies. The inquiry is not exclusively subjective, but neither is it a purely objective comparison between the agreed price and a later valuation. A genuine arm’s-length commercial transaction stands even if it appears, with hindsight, to have been a bad bargain. By contrast, a pretence of an arm’s-length sale used to extract value for a shareholder is unlawful. This approach was consistent with Aveling Barford Ltd v Perion Ltd [1989] BCLC 626.
3. Lord Mance identified a sufficient further basis for rejecting the claim. The reduced payment reflected the value placed on PPC’s supposed counter-indemnity liability and its release. That presentation may have been illogical as a valuation of the subsidiary, but the court had to identify the commercial reality. A director’s mistaken or ill-advised acceptance of a supposed independent liability does not, without more, turn its settlement or release into a distribution of capital.
4. On the concurrent findings, the sale was a genuine commercial sale. It was not pleaded or put to the common director that it was a disguised extraction of value. The appellant’s proposed recategorisation of the agreement as a distribution therefore failed, and no further valuation or quantum proceedings were required.

• United Kingdom Supreme Court: dismissed the appeal and affirmed the dismissal of the claim.
• Court of Appeal: Mummery, Toulson and Elias LJJ unanimously upheld the deputy judge’s dismissal: [2009] EWCA Civ 629; [2010] 1 BCLC 1.
• Deputy judge: dismissed the action on 15 October 2008 on the basis that it could not succeed even on the assumed undervalue and breach of duty.