Date: 09/08/2021 | Corporate
Unfortunately, we regularly see the detrimental effects an incorrect Companies House register can have on a company, not only in terms of costs but also in terms of lost opportunities. For obvious reasons we cannot identify the companies, instead we will refer to our examples as Lily Limited, Carnation Limited, Honeysuckle Limited and Foxglove Limited - as a rose by any other name would smell as sweet or in this case sour…
Case Study 1 – Lily Limited
In 2015 Lily Limited carried out a buyback of its own shares. It purchased 1,900 shares for a total consideration of £2m from a single shareholder.
There are specific requirements in regard to the buyback of shares as set out in chapter 18 of the Companies Act 2006. These requirements include a list of the specific documents which need to be filed, how a buyback is to be funded, i.e., from distributable reserves or from the proceeds of a fresh issue, and the penalties for acting in contravention of the rules. Failure to meet one of these conditions results in, amongst other things, the buyback being void - which means that in effect it never happened.
Although Lily Limited filed a number of the required buyback documents it did not file all the required documents and also filed some documents that were simply not relevant. As a result, we had to advise that the buyback was void.
Well, the impact of this mistake was a costly one. As the buyback was void this meant that the shareholder had never ceased to be a shareholder and the buyback had to be done again, but this time properly. Also the majority of the documents subsequently filed at Companies House, including accounts and annual returns/confirmation statements, were incorrect. Fixing seven years of incorrect Companies House filings is not a quick or cheap job and combined with the need for additional legal and tax advice, the costs started to mount.
Luckily in this case the parties involved in the original transaction were all still on good terms, and more importantly alive. The consequences of that being otherwise would have been disastrous.
Case Study 2 – Carnation Limited
Carnation Limited is another example of a failed buyback of shares. In 2018 the company wanted to purchase 200 shares from two connected shareholders. Again, a relatively straightforward process as long as the requirements are followed.
However, the company’s advisor did not have any of the correct documents entered into by the parties nor file any of the required returns; instead, they simply removed the shareholders and the shares from the company’s 2019 confirmation statement. There were no other filings between the 2018 confirmation statement and 2019 confirmation statement, which made the mistake more obvious.
Once again, the impact of this mistake was costly. Although perhaps not as costly as Lily Limited because there were only four years of incorrect filings and the sum of money was significantly less, it was unnecessarily costly nonetheless.
This issue came to light when the company wanted to bring another individual in as a shareholder, to bring additional expertise and innovation to the company. Thankfully for Carnation Limited, the issue was resolved quickly by having the correct documentation put in place and filings made at Companies House. The new shareholder continued with their investment in the company. However, this might not have been the case if the faulty buyback could not have been corrected.
Most investors and potential buyers will carry out a due diligence check on a company’s Companies House register and statutory books and if everything does not stack up this may be where their interest in the company ends. But I will explore this in our fourth case study.
It is also worth noting that banks look at Companies House before opening an account for a company and before providing any sort of facility, including an overdraft or loan. If the register does not meet their expectations, then the banks will simply not provide the services required.
Case Study 3 – Honeysuckle Limited
Once again, this company was victim to a failed buyback in 2019. In this case the company had sent the form SH03 to the stamp office to be stamped and had filed the stamped form at Companies House. However, they had failed to file the remaining required documents, so once more this buyback was void.
Well in short, Honeysuckle Limited had to correctly carry out the buyback in 2021, which unsurprisingly had cost and tax implications but there is no mercy in flogging a dead horse…
It is worth looking at the tax implications when a buyback is found to be void. A buyback cannot be completed for nil consideration. So, in each of our case studies the payment made for the original ‘buyback’ is, in legal terms, treated as a loan which impacts the tax position of the company and the shareholder. There are also tax implications on the shareholder if they repay the loan and equally tax implications if they do not. From an accounting viewpoint it may be possible to apply the doctrine of “form over substance” but this will be not always be the case.
Moreover, physical payment has to be made on a buyback of shares. Which means that you cannot simply write off the loan against the consideration, as you may be able to do with other such transactions. This can create additional complexities. For example, in the case of Lily Limited, it is unlikely that anyone would continue to have £2 million squirreled away for nearly a decade. On the other hand, not many would have the surplus assets or ability to raise funds for this sort of value. This may seem easy to resolve – just purchase the shares for less. However, to purchase the shares for considerably less money can have an impact on the valuation of the business. This is a particularly complex matter where the legal, accounting and tax advice do not always come to the same conclusions, which is why the costs of the remedial work can mount.
So far, our case studies have all been examples where the exiting shareholder left on amicable terms. But what if this was not the case? Say for example, a company has a disgruntled shareholder who, only after months or years of negations, has been bought out of the company. Such an individual, who due to the failed buyback never ceased to be a shareholder, may see this as an opportunity to return to the company. Alternatively, they may see this as their opportunity to get more money for their shares if they believe that they did not get what they were owed the first time. This added difficulty would increase the additional time and costs.
Case Study 4 – Foxglove Limited
Foxglove Limited, unlike our previous three case studies, does not focus solely on a failed buyback. This is a situation where everything that could go wrong did go wrong.
Foxglove Limited instructed an advisor to arrange the incorporation of the company and subsequently to deal with all Companies House filings and general company secretarial matters. The company was incorporated in 2014 and during the course of the company’s lifespan had purported to complete several share transfers, various allotment of shares, reclassification of shares, sub-division of shares and a share buyback.
However, there were plenty of examples of missing or incorrectly filed documents on this company’s Companies House Register. In some cases, the forms were simply not filed. In other cases, the documents filed were legally incompetent. This resulted in many of the share capital structure changes being void.
The issue with this company was that the advisor did not exercise the requisite standard of professional knowledge, skill and care which resulted in fundamental defects in the share capital of the company. Simply adding or subtracting information in a company’s annual return/confirmation statement does not constitute a validly executed change in share capital structure.
The Companies House register for Foxglove Limited was such a bag of bolts that no one could make head nor tail of what the share capital of the company was or who the shareholders should have been. When issues are detected at Companies House, the normal course would be for the company’s statutory registers to be reviewed and this usually allows the correct position to be ascertained. However, no such statutory registers (which are a legal requirement) were created or maintained by the advisor.
As the company had instructed an advisor, they did not look too deeply at what was filed at Companies House because, and not unreasonably, presumed that it had been dealt with correctly.
Unfortunately, all these issues reared their ugly heads when a proposed buyer started their due diligence process.
Buyers expect some level of discrepancies at Companies House but they take a risk based approach and usually the risks can be managed to an acceptable level. However, Foxglove Limited could not give the potential buyer any satisfising resolution to all of the issues which were identified and unsurprisingly the buyer aborted the deal.
Luckily for Foxglove this particular buyer was keen to purchase the business so proposed an alternative structure. This alternative structure would see the business and assets of Foxglove Limited moved to a Newco. However, not all was well. Although this alternative structure resolved the issue for the buyer the consequences were vast. Firstly, it left the shareholders of Foxglove as shareholders of a shell. Secondly, the costs involved in the additional work cost the company a very substantial amount in additional – and unnecessary – professional fees. Thirdly, the tax implications on this structure were substantially different and less favourable to the seller. However, it was a case of this deal or no deal.
What can you do?
When you consider the cost of correcting a company’s Companies House Register against the fact that most forms can be filed at Companies House for free, you can see why the consequences of incorrect filings can leave such a sour taste in the mouth.
Understanding the Companies Act 2006, Companies House forms and the associated guidelines is akin to wading through mud; which is significantly easier with the correct equipment. For example, many would assume that those who appear at Companies House are the company’s members but this is not correct - a company’s members are those that appear in the company’s statutory registers as set out in the Companies Act.
The most important step to take in any transaction is to seek the appropriate advice. The benefits of seeking the correct advice, rather than acting first and asking questions later are substantial.
There are very few errors that cannot be fixed and in the main, errors can be corrected using Companies House forms. However, there does come a point where a register becomes so entangled in discrepancies that it is impossible to fix all the mistakes, or the cost in doing so outweighs the value of the company.
If what I have written does not persuade you that things should be done correctly, then you should look for an article by Robert Watts in the Sunday Times of 4 July about a totally fictitious company used in a crypto currency fraud. This shows how easy it is for the Companies House processes to be abused and, without proper due diligence being done, as a result investors can lose their money.
If you take away one piece of advice from this article, please let it be this: it is a legal requirement for information to be filed at Companies House and for statutory books to be created and maintained, it is also a legal requirement (and generally just good corporate governance) to ensure, where possible, that this information is accurate and up-to-date. There are advisors willing, and more importantly able, to help you with this. There is no reason to lose an opportunity or suffer additional costs due to errors in process and a discrepancy filled Companies House register.
If you would like to discuss any matters related to this article, please contact a member of our Corporate Team.
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