Ventura Capital GP Limited & Anor. v DnaNudge Limited

The court was asked whether a provision in a company’s articles providing for the automatic conversion of Series A preferred shares into ordinary shares could operate to extinguish the special rights attaching to those preferred shares without the consent required by article 10.1 of the articles and, if it could, whether the conversion should be set aside as unfairly prejudicial under section 633 of the Companies Act 2006.

The judge held that the literal operation of article 9.2(a) (automatic conversion on notice from an 'Investor Majority') would, in reality, extinguish the special rights attached to the preferred shares and so create a clear tension with article 10.1 (which provides that special rights of a class may only be varied or abrogated with the written consent of more than 75% in nominal value of that class). Applying the principles of construction appropriate to articles of association and limited admissible extrinsic evidence, the court concluded that article 9.2(a) must be read subject to article 10.1. For that reason the purported conversion was declared invalid, void and of no effect.

The judge also considered section 633 but, on the alternative hypothesis that the conversion had been effective under the articles, was not satisfied that unfair prejudice had been established on the facts; that part of the claim therefore failed on its merits, although it was strictly unnecessary to decide it in view of the primary declaration granted.

Background and parties: DnaNudge Limited had issued Series A preferred shares carrying special preferential rights. The claimants, Ventura (acting for two limited partnerships), and a single other preferred shareholder (SMTB), together held all Series A preferred shares. A provision in the articles (article 9.2(a)) permitted an Investor Majority to give notice that would automatically convert all Series A shares into ordinary shares. Article 10.1 provided that special rights attached to any class could only be varied or abrogated with the written consent of more than 75% in nominal value of that class. Ventura and SMTB objected to a conversion notice said to have been served by an Investor Majority and sought declarations and relief.

Nature of the claim and relief sought: The Part 8 claim sought (i) a declaration that the purported conversion of Series A shares into ordinary shares was invalid, void and of no effect because it amounted to a variation or abrogation of class rights without compliance with article 10.1, and (ii) alternatively, relief under s. 633 Companies Act 2006 to disallow the variation or abrogation as unfairly prejudicial.

Issues framed: (i) Whether conversion under article 9.2(a) amounted to a variation or abrogation of the special rights attached to the Series A shares; (ii) if so, whether article 9.2(a) must be read as subject to article 10.1 (either by construction or by implication) so that conversion could not be effective without the class consent required by article 10.1; and (iii) if conversion were effective, whether the variation or abrogation would unfairly prejudice the preferred shareholders under s. 633.

Admissible evidence and approach to construction: The court applied the established, narrower approach to construing articles of association: focus on the natural and ordinary meaning of the words, the scheme and purpose of the articles, and any background material that would be reasonably ascertainable by a reader of the company constitution and public filings at Companies House. Extrinsic evidence was therefore limited.

Court’s reasoning: On a literal reading article 9.2(a) provided for automatic conversion on an Investor Majority notice. The judge found that the practical effect of such a conversion would be to extinguish the special rights of the preferred shares because there would be no preferred shares in issue after conversion. That conclusion created a clear conflict with article 10.1. The court treated the conflict as a rare drafting error of the sort that justifies corrective construction or the implication of a limiting term. To give business efficacy to the articles and to reflect the reasonable expectations of shareholders (in light of publicly available filings showing a substantial premium paid for the preferred rights), the court implied a limitation into article 9.2(a) that conversion under that article is subject to first obtaining the consent required by article 10.1. Applying that corrected construction, the purported conversion had not complied with article 10.1 and was invalid, void and of no effect.

Further points: The court briefly addressed s. 633 and concluded that, if the conversion had been effective under the articles, the claimants had not established unfair prejudice on the facts; however that alternative analysis was not necessary to dispose of the case because of the primary declaration granted.

The claim is allowed in part. The court declared that the purported conversion of the Series A preferred shares into ordinary shares was invalid, void and of no effect because article 9.2(a) must be read as subject to article 10.1 and the 75% class consent required by article 10.1 had not been obtained. The judge implied a limiting term (or applied corrective construction) to give business efficacy to the articles. The alternative claim under s. 633 Companies Act 2006 was considered but, on the artificial hypothesis that conversion had been effective under the articles, unfair prejudice was not established; that alternative limb was unnecessary in view of the primary declaration granted.