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Consent to conversion of preference shares

Author: Woodfines Solicitors
Published On: 5 July 2023

DnaNudge Ltd, Re [2023] EWHC 437 (Ch)

The High Court has considered whether the conversion of preference shares into ordinary shares constitutes a ‘variation or abrogation of the special rights’ attaching to the preference shares in Re DnaNudge Ltd.

Preference shares can be vital to obtaining investment because they can give investors a priority return on their investment through dividends and capital. In Re DnaNudge, the Company’s Articles of Association included an article (9.2(a)) which said that a majority of all shareholders, both preference and ordinary shareholders combined (‘Investor Majority’), could convert the preference shares into ordinary shares by notice to the holders of the preference shares. Article 10.1, on the other hand, said that special rights attached to a class of shares could only be ‘varied or abrogated’ with the written consent of more than 75% in nominal (face) value of the issued shares of the affected class.

A dispute arose over whether a conversion is a variation or abrogation and whether article 9.2(a) operates independently of article 10.1, or whether the consent of the preference shareholders must be obtained, after an Investor Majority gave notice to the preference shareholders, purporting to be a notice to convert their shares into ordinary shares.

It’s readily apparent that an investor would have been well advised to refuse to agree to article 9.2(a) when negotiating the terms of their investment if it wasn’t subject to article 10.1. If the ordinary shareholders could group together at any time to strip the preference shares of their preferred nature, their value to the investor would be dramatically reduced. The preference shareholders in this case argued that article 10.1 was intended to protect their interests against exactly such a scenario and that it would be ‘commercially absurd’ for article 9.2(a) to be able to be used without being subject to article 10.1.

The High Court considered the two articles in their proper context and concluded that the conversion of shares of one class to another class is a ‘variation or abrogation’ of the rights attached to them because after such a conversion the special rights attached to the preference shares fall away.

Secondly, the Court concluded that the conversion was ‘invalid, void and of no effect’ because a ‘variation or abrogation’ of the rights attached to the preference shares required consent from holders of more than 75% of value of the preference shares and this had not been obtained. So, article 9.2(a) was subject to article 10.1.

The Judge considered that this interpretation of the two articles was necessary to give ‘effect to the true bargain made between the company and all its shareholders, whereby they always intended that the special rights attached to the preference shares should enjoy effective protection from any attempt to vary or abrogate them.’ He noted that the investors had paid a substantial premium on the preference shares and that the Articles would be absurd on the Defendant’s interpretation of them.

Another point arising out of the judgement: in this case, it was blatantly obvious to the judge from the Articles themselves and the forms filed at Companies House that the parties must have intended to give the investors adequate protection for their investment but it’s very important to get your Articles right first time because the Courts won’t consider extrinsic evidence when considering their interpretation, beyond that

The High Court has considered whether the conversion of preference shares into ordinary shares constitutes a ‘variation or abrogation of the special rights’ attaching to the preference shares in Re DnaNudge Ltd.

Preference shares can be vital to obtaining investment because they can give investors a priority return on their investment through dividends and capital. In Re DnaNudge, the Company’s Articles of Association included an article (9.2(a)) which said that a majority of all shareholders, both preference and ordinary shareholders combined (‘Investor Majority’), could convert the preference shares into ordinary shares by notice to the holders of the preference shares. Article 10.1, on the other hand, said that special rights attached to a class of shares could only be ‘varied or abrogated’ with the written consent of more than 75% in nominal (face) value of the issued shares of the affected class.

A dispute arose over whether a conversion is a variation or abrogation and whether article 9.2(a) operates independently of article 10.1, or whether the consent of the preference shareholders must be obtained, after an Investor Majority gave notice to the preference shareholders, purporting to be a notice to convert their shares into ordinary shares.

It’s readily apparent that an investor would have been well advised to refuse to agree to article 9.2(a) when negotiating the terms of their investment if it wasn’t subject to article 10.1. If the ordinary shareholders could group together at any time to strip the preference shares of their preferred nature, their value to the investor would be dramatically reduced. The preference shareholders in this case argued that article 10.1 was intended to protect their interests against exactly such a scenario and that it would be ‘commercially absurd’ for article 9.2(a) to be able to be used without being subject to article 10.1.

The High Court considered the two articles in their proper context and concluded that the conversion of shares of one class to another class is a ‘variation or abrogation’ of the rights attached to them because after such a conversion the special rights attached to the preference shares fall away.

Secondly, the Court concluded that the conversion was ‘invalid, void and of no effect’ because a ‘variation or abrogation’ of the rights attached to the preference shares required consent from holders of more than 75% of value of the preference shares and this had not been obtained. So, article 9.2(a) was subject to article 10.1.

The Judge considered that this interpretation of the two articles was necessary to give ‘effect to the true bargain made between the company and all its shareholders, whereby they always intended that the special rights attached to the preference shares should enjoy effective protection from any attempt to vary or abrogate them.’ He noted that the investors had paid a substantial premium on the preference shares and that the Articles would be absurd on the Defendant’s interpretation of them.

Another point arising out of the judgement: in this case, it was blatantly obvious to the judge from the Articles themselves and the forms filed at Companies House that the parties must have intended to give the investors adequate protection for their investment but it’s very important to get your Articles right first time because the Courts won’t consider extrinsic evidence when considering their interpretation, beyond that readily available on public registers free of charge at Companies House. The Judge was not willing to look at the Shareholders Agreement when considering the matter.

It should be noted that at the time the judgement was issued in March, the Defendant intended to appeal to the Court of Appeal. In view of the sums involved (the preference shares were subscribed for at over £40 million), this is not altogether surprising.

readily available on public registers free of charge at Companies House. The Judge was not willing to look at the Shareholders Agreement when considering the matter.

It should be noted that at the time the judgement was issued in March, the Defendant intended to appeal to the Court of Appeal. In view of the sums involved (the preference shares were subscribed for at over £40 million), this is not altogether surprising.

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