OUTER HOUSE, COURT OF SESSION [2006] CSOH77A
P2518/05	OPINION OF LORD DRUMMOND YOUNG in the petition of MARTIN CURRIE LIMITED Petitioners; for for an order confirming the cancellation of its share premium account ________________

Act: Borland; Allan McDougall for Dickson Minto WS

17 May 2006

[1] The petitioners are the holding company of a well-known fund management group. In the present petition they seek confirmation of the cancellation of their share premium account. As is usual in such petitions the petitioners ask the court to declare that the provisions of sections 136(3) to (5) of the Companies Act 1985 should not apply as regards the company's creditors or any class of those creditors. Those subsections provide, in summary, that creditors of the company may object to the reduction, and certain procedures are prescribed to that end. Subsection (6), however, gives the court power to dispense with the application of subsections (3) to (5).

[2] The petition was remitted to a reporter, Mr Julian Voge, WS, to inquire into and report upon the facts and circumstances set forth in the petition. He has produced a detailed and helpful report. The present opinion proceeds upon the findings in that report.

[3] As at the date of presentation of the petition, the amount standing to the credit of the company's share premium account was £1,910,559. On confirmation of cancellation, that credit will be cancelled and the same sum will be transferred to a special reserve. The company proposes that the amount standing to the credit of that reserve should be applied in crediting a distributable reserve. That reserve would be treated as realized profits of the company, and could be applied in any manner in which the company's profits available for distribution (as determined accordance with section 263(3) of the Companies Act 1985) may be applied. In particular, the reserve would be available for to make distributions to the members. This is not a case in which the company has undertaken to create a reserve that is not distributable as long as sums owed to any of the company's existing creditors remain outstanding.

[4] The proposed cancellation of the company's share premium account does not in itself involve either the diminution of liability in respect of unpaid share capital or the payment to any shareholder of any paid up share capital. It is nevertheless the practice of the court, in cases where a distributable reserve is created, to consider whether any creditors of the company require the protection given by section 136(3) to (5) of the Companies Act 1985: Quayle Munro Ltd., 1993 SLT 723. In such cases, the court will normally dispense with the application of sections 136(3) to (5) if the company's margin of solvency is such that no relevant creditor is likely to be prejudiced by the cancellation. In considering the margin of solvency, the normal practice of the court is to consider whether the company's readily realizable assets are sufficient to provide for both the amount owed to relevant creditors and the amount that the company would be entitled to return to its shareholders, with a reasonable margin of safety.

[5] In the present case the amount that will be made available for distribution to shareholders as a result of the proposed cancellation of the share premium account is the sum of £1,910,559 mentioned in paragraph [3] above. In addition, the company's balance sheet as at 30 September 2005 indicates that the company had existing distributable reserves of £668,114. Thus a total of £2,578,673 might be distributed to creditors. In the same balance sheet the company's total liabilities are stated at £7,715,110. A letter has been produced from the company's finance director confirming that as at 24 November 2005 (a date immediately before presentation of the petition) there had been no material adverse changes in the company's financial position from that disclosed in the balance sheet as at 30 September. It is accordingly appropriate to regard the foregoing figure of £7,715,110 as a reasonable indication of the amount likely to be due to creditors. All of the company's known creditors have consented to the cancellation of the company's share premium account. Nevertheless, the petitioners acknowledge that unknown or unexpected creditors might emerge. In particular, HM Revenue and Customs have not consented to the cancellation and, while no amounts were due to them as at 30 September 2005, it is possible that such a liability might exist. In considering whether there is adequate protection for non-consenting creditors, it is necessary to aggregate the sums due to both consenting and non-consenting creditors, except to the extent that the non-consenting creditors have subordinated their debts to the company's general creditors. That is because, in the event of insolvency, consenting and non-consenting creditors will rank equally unless there has been an express subordination. Of the sum of £7,715,110 due to the company's creditors, £2,093,705 is due to subsidiary companies within the Martin Currie group. Those creditors have agreed to subordinate the debts due to them to all unknown or unexpected creditors of the company as at the date of the final hearing of the petition. For this reason, in considering the company's margin of solvency, it is appropriate to disregard the sum of £2,093,705 due to subsidiaries. The appropriate creditors figure for the calculation is that relating to the unsubordinated creditors, namely £5,621,405.

[6] It follows that the company must have sufficient resources to cover the sum of £5,621,405 due to unsubordinated creditors. As I have already mentioned, the normal practice followed by the court is to consider whether that sum is covered by readily realizable assets. Cash and gilt-edged securities have always been regarded as readily realizable assets. In Anderson Brown & Co Ltd., 1965 SC 81, it was pointed out that, although there was no reported decision on the matter, it had long been the practice of the court not so to limit the category of readily realizable assets. In that case it was held that the amount due by debtors might be taken into account, provided that an appropriate provision was made for bad debts and that the reporter was satisfied that the petitioners had been regularly and punctually paid by their debtors and had regularly and punctually paid their own creditors. Lord President Clyde stated (at 83) that the issue that arose under the predecessor of section 136(6) was whether, having regard to the special circumstances of the case, it was proper to dispense with the inquiry provided for in what is now subsections (3) to (5). That conferred upon the court a certain element of discretion. It was in the light of that discretion that the court was willing to take debtors into account, provided that certain conditions were satisfied. Since the foregoing decision it has become the regular practice of the court to take listed securities into account in calculating a company's readily realizable assets. This reflects the fact that there is an effective market in such securities. No doubt the value of listed securities may fall, but that possibility can be taken into account by allowing an appropriate margin of safety above the figure for readily realizable assets.

[7] In the present case the company holds listed investments which were valued as at 30 September 2005 at £1,400,151. Those constitute readily realizable assets. On the same date the company had trade debtors of approximately £15,000 and group debtors (subsidiary companies that owed money to the company) of £1,500,000. The company's finance director has confirmed that provision is made for bad debts and that historically both classes of debtor have regularly and punctually paid the company timeously and in full. On that basis, in accordance with the principles laid down in Anderson Brown & Co Ltd. supra, those debts can be taken into account as readily realizable assets. As at 30 September 2005 the company also held unlisted investments valued in the balance sheet at £124,865. In addition it had investments in subsidiary undertakings that were valued at £8,307,921. The latter two types of investment would not be categorized as readily realizable assets. I was nevertheless asked to take the unlisted investments in subsidiary undertakings into account in the margin of solvency calculation. In advancing that submission counsel for the petitioners relied upon the following factors.

[8] In the first place, counsel drew attention to the nature and strength of the company's business. The company is the ultimate holding company of the Martin Currie group, an investment management business which as at 30 June 2005 managed approximately £8.7 billion in active equity portfolios for clients in Europe, North America and elsewhere. In the year ended 30 September 2005 the company made an unaudited net profit after tax of £11,701,897. In the years ended 30 September 2004 and 30 September 2003 the company's audited net profit after tax was £5,815,499 and £3,806,948 respectively. In the second place, counsel referred to certain independent evidence regarding the valuation of the company. During 2005 the company effected a financial reconstruction when certain employee shareholders retired and sold their shares in the company. For the purposes of those transactions the company was valued at between £86,900,000 and £90,400,000 by an independent investment bank, Cazenove & Co Ltd. (now J P Morgan Cazenove Ltd.). That value was very largely attributable to the company's investments in its wholly-owned subsidiaries. The company acted as the holding company for the group, and the investment management activities were carried out by its subsidiary companies. Consequently the goodwill attributable to the group's business would belong in the first place to the subsidiaries, and would be reflected in the value of the shares that the company held in those subsidiaries. Moreover, when the retiring employee shareholders sold their shares the price that was ultimately agreed was £15.80 per ordinary share. On that basis the entire issued share capital of the company would be valued at over £110,000,000. Those figures, ranging from £86,900,000 to £110,000,000, had to be contrasted with the figure of £8,307,921 that appears in the company's balance sheet; that indicated that the latter figure was conservative in the extreme. I observe at this point that the figure in the balance sheet will have been determined in accordance with established accounting conventions. One of these is that assets are normally carried at the lower of cost and net realizable value. The balance sheet figure is therefore likely to represent either the original cost of the investments or a revalued figure that was established several years ago. I consider that counsel is quite correct in submitting that that figure is very conservative.

[9] In my opinion the company's investments in subsidiary undertakings may be taken into account in the margin of solvency calculation, on the basis set out below. In reaching that conclusion I have had regard to the approach taken by the courts in two decided cases. First, in Re Lucania Temperance Billiard Halls (London) Ltd., [1966] Ch 98, Buckley J., in considering the provision to be made for rent liabilities under a large number of leases, stated (at 107) that "some recognition of reality must ... be admitted in the exercise of the court's discretion under section [136(6)]". In my opinion it is important that, in their approach to the margin of solvency calculation, the court should had regard to commercial realities, and in particular to the changing circumstances of the commercial world. Secondly, in Unifruitco Steamship Company Ltd., 1930 SC 1104, the First Division sanctioned a reduction of capital by a shipping company. The company's only debts resulted from expenditure incurred by ships in the course of their voyages, and such debts were in practice regularly discharged. It was held that the value of the company's ships was ample security for the outstanding debts. Ships might not normally be regarded as readily realizable assets. Nevertheless, Lord President Clyde referred to the fact that the company was a large and flourishing one. This case is a clear example of the court's taking account of the financial state of the company as a whole, and having regard to the commercial realities of its business.

[10] The normal rule is that, in considering a company's margin of solvency, the court will only have regard to readily realizable assets. Nevertheless, I am of opinion that that rule may be subject to exceptions. As is emphasized by Buckley J. in Re Lucania Temperance Billiard Halls (London) Ltd. and Lord President Clyde in Anderson Brown & Co Ltd., the court has a discretion under section 136(6). I do not think that that discretion should be rigidly constrained by a formulaic approach to the margin of solvency. Ultimately, the critical question is whether there is any significant risk of prejudice to the company's existing creditors, in the sense that those creditors may not have their debts paid in ordinary course. If it appears from the totality of the facts put before the court about the company and its business that no such risk exists, I am of opinion that the court may dispense with the requirements of section 136(3) to (5), even if the formula based on readily realizable assets is not satisfied. In considering the risk to creditors, a range of matters may be taken into account. These include the general financial strength of the company, measured by either earnings or the valuation of the company's shares. (These two are of course likely to be related). Also relevant is the likelihood or otherwise that a purchaser will be found for assets that do not fall into the readily realizable category. In this connection an important consideration is the growth in recent years of private equity funds. This appears to have been prompted in large measure by what is perceived as the overregulation of public companies. Nevertheless, the result has been that large amounts of money are available to purchase shares in private companies. That inevitably has a major effect on the marketability of holdings such as those that the company has in its subsidiaries. In my opinion the courts must have regard to the existence of large private equity funds if their approach to company law is to reflect current commercial reality.

[11] In the present case I am satisfied that the court's approach to section 136(6) should not be constrained by the company's lack of sufficient readily realizable assets to cover the amounts that may be returned to shareholders and its existing creditors. I reach this conclusion for three reasons. In the first place, it seems clear that if the company were compelled to realize its holdings in subsidiary companies it could do so without difficulty. Because the subsidiaries are private companies there is no formal market in such shares, as there is with public companies. Nevertheless the valuation placed on the company by Cazenove & Co Ltd. is a clear indication that potential purchasers, with the necessary resources, do exist, and that there is a market for the company's shares While the sale would take longer than the sale of shares in a public company, I think it clear that such a sale would take place. In the second place, I propose to take the shares in subsidiary companies into the margin of solvency calculation at the balance sheet value. It is quite clear that that value is well below the current value of the shareholdings. The balance sheet figure is £8,307,921. That must be contrasted with recent valuations of the company as a whole, which range from £86,900,000 to £111,000,000; the latter figures in effect represent the value of the subsidiaries, because the company only trades through its subsidiaries. On this basis there is a very large element of safety built into the margin of solvency calculation. That in itself confers a strong protection on the company's creditors. In the third place, it is clear that the company itself is successful and prosperous; that is indicated by its recent profit figures, which in turn are reflected in the recent valuations of the company as a whole. That is I think a consideration that can be taken into account in determining whether the court should dispense with the requirements of section 136(3) to (5); ultimately the critical question is the risk to creditors, and that risk is clearly low if their debtor is a successful and prosperous company.

[12] For the foregoing reasons I am of opinion that it is appropriate to take the company's shareholdings in its subsidiaries into account in the margin of solvency calculation. I consider it appropriate to take those holdings at the valuation in the company's balance sheet. It could certainly be argued that a higher valuation than that is appropriate in view of the evidence about the total value of the company. It is not necessary to consider that possibility, however, because the book valuation is quite sufficient to cover both the creditors and the amounts that might be distributed to shareholders. A total of £2,578,673 will be available for distribution to shareholders following the cancellation of the share premium account, and unsubordinated creditors amount to £5,621,405. The company has listed investments valued at £1,400,151, trade debtors amounting to £15,000 and group debtors amounting to £1,500,000. Those are all readily realizable assets. To those should be added the shareholdings in subsidiary companies, at their balance sheet value of £8,307,921. That produces a figure for total relevant assets of £11,223,072. The difference between the relevant assets, valued on the foregoing basis, and unsubordinated creditors is £5,601,667. If the whole amount available for distribution were in fact distributed, that difference would fall to £3,022,994. In either event, that is a substantial margin. In my opinion that margin is quite sufficient to provide full protection for the company's creditors; I do not think that there is any significant risk that their debts will not be paid in full as they fall due. This conclusion is fortified by two further considerations. First, it is relevant that the valuation of £8,307,921 placed on the shareholdings in subsidiaries is extremely conservative; that in itself increases the margin of solvency to a substantial extent. Secondly, it appears most unlikely that the whole of the distributable reserves would in fact be distributed by the company. In the financial year ended 30 September 2005 the company paid dividends amounting to £751,789 to shareholders. It was confirmed to the reporter that the company's intention was to maintain the same dividend policy in the future.

[13] I have accordingly directed that subsections (3) to (5) of section 136 of the Companies Act 1985 should not apply as regards the creditors of the company. Subject to that, I have confirmed the cancellation of the company's share premium account.