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M&A Diligence: rectification of a share purchase agreement ordered to enable entrepreneurs' relief
In the recent case of Prowting 1968 Trustee One Limited and others v Barry Amos-Yeo and Kevin Amos-Yeo  EWHC 2480 (Ch), the High Court ordered share transfer documents to be rectified such that subsequent disposal of the shares involved qualified for entrepreneurs’ relief.
Entrepreneurs’ relief can be claimed by entrepreneurs selling their businesses, and reduces the rate of capital gains tax on the disposal of shares in the business from the top rate of 28% to just 10%. In order for the relief to apply on a share sale:
- the entrepreneur must have held (for at least 12 months prior to the sale) at least 5% of the nominal share capital giving them at least 5% of the voting rights; and
- the entrepreneur must have been a director or employee of the company (or within the same group); and
- the company’s main activities are in trading (rather than non-trading activities like investments).
In the Prowting case, shares in Banner Homes Group plc held by two settlement trusts and the settlor where transferred to the settlor’s grandsons (Barry and Kevin Amos-Yeo) in preparation for a sale of the company. Each grandson acquired 115,000 A shares of £0.50 in the company (being 5.5% of the total number of shares) on the basis that this would entitle him to entrepreneurs’ relief at the time of sale. These were voting shares, and so gave each grandson more than 5% of the voting rights. However, as the other issued shares of the company had differing nominal values (from £0.01 to £1.00), the shares acquired represented only 4.97% of the overall nominal share capital.
The error was discovered shortly before the sale, and a claim was brought by the trustees to rectify the share purchase agreements to increase the number of shares transferred in order to ensure that entrepreneurs’ relief was available. In granting the order for rectification, Master Clark was clear to emphasise that “as a discretionary remedy, rectification is to be treated with caution” and that the case was decided on the facts alone, but gave a useful summary of the requirements for establishing mistake at law.
To enable rectification, the parties must show that:
- there is a common continuing intention (which was outwardly and demonstrably expressed); and
- by mistake, the relevant signed document did not reflect their true intention.
Put another way, there must be clear evidence that the true intention of the parties was not given effect by the document, as opposed to the document merely failing to achieve the desired financial goal. On this point, Master Clark noted that the “distinction between the two is not always clearcut”. Indeed, there are recent examples of case law where the Court, with not dissimilar facts, has dismissed claims for rectification. Kennedy v Kennedy  EWHC 4129 (Ch) involved a transfer of assets where the parties mistakenly assumed that losses were available to be set off so that the overall transaction would not result in the rise of a chargeable gain. The Court in this case found that the mistake was for “purely factual reasons, extraneous to the document itself” and refused rectification. Similarly, in Allnut v Wilding  EWCA the Court of Appeal held that there should be no rectification where a discretionary trust had been established on the mistaken belief that a transfer into the trust would be exempt from inheritance tax (rather than, as happened, there being an immediate lifetime charge). The basis of the Court of Appeal’s decision was that there was no mistake as to the effect of the trust document itself, only as to the financial consequences of the transfer.
In the Prowting case, the fact that the trustees of the settlement trusts had made a mistake in ignoring the different nominal capital values did not prevent rectification (even though in doing so, the transfer failed to achieve the desired fiscal outcome). There was no miscalculation; rather, the trustees failed to make any calculation at all – they assumed wrongly that the nominal capital was equal across all classes of shares and did not bother to check.
Prowting suggests a further movement by the Courts away from finding mistake (and therefore allowing rectification) where there is a general intent which is not reflected in a document, to where there is a general intent which is not reflected due to a specific error contained within the document. However, given the specific facts, this should not be taken as a general principle that the Court is willing to step in and correct bad draftsmanship. It also shows the importance of calculating the nominal value as well as the voting rights when it comes to determining thresholds for entrepreneurs’ relief.
For more information, please contact Andy Moseby, Corporate partner.