DnaNudge: conversion of shares, variation of class rights and interpretation of articles of association

Two conflicting provisions

Two new investors invested in a company in return for preference shares. The articles were amended as part of the arrangement, and the amended articles contained the following two provisions (without dealing with the interplay between them):

• One provision said an investor majority could convert preference shares into ordinary shares by notice in writing.
• Another provision said that changes to class rights required the consent of 75% of the relevant class. 

An investor majority was defined here as the holders of a majority of the preference shares and ordinary shares in aggregate (and this was controlled by the ordinary shareholders). An investor majority gave notice to convert the preference shares into ordinary shares. The preference shareholders challenged the ability of the investor majority to effect a conversion in this way. They also made use of their right under section 633 of the Companies Act 2006 for holders of at least 15% of a class to challenge a purported variation of class rights on the basis that the conversion constituted a variation of class rights which would unfairly prejudice them.

How to reconcile them

The key question was how the two article provisions interrelated. The judgments in both the High Court and the Court of Appeal confirmed that, when faced with two provisions in a company’s articles which seem to be inconsistent, the court will seek to interpret those provisions in a coherent, rational and commercially sensible way. Both courts considered that no reasonable person would think the investor majority could simply wipe out the preference shareholders’ rights on a whim. So, the answer—both as a matter of corrective construction and by the use of an implied term—was that the provision giving an investor majority the right to convert preference shares into ordinary shares had to be read as being subject to the provision requiring class consent for a change to class rights.

The Court of Appeal also held that, in the circumstances of the conflicting provisions, the ability of the investor majority to trigger a conversion of the preference shares into ordinary shares amounted to an abrogation (variation) of the preference shareholders’ rights; not a performance of those rights. Helpfully, it also commented obiter that, in the absence of the inconsistency, the ordinary shareholders and the company would not have been acting unfairly (for the purposes of section 633) by simply giving effect to the provision of the articles allowing the ordinary shareholders to trigger a conversion of the preference shares.

Lessons for the future

Generally, the approach to interpreting articles of association is the same as that for contracts but the Court of Appeal did make the following observation: 

“The articles of association of a company apply to the potentially fluctuating body of members who acquire shares in a company, some of whom may have no knowledge of the circumstances which applied when the articles were adopted or amended. The articles are also publicly registered at the Companies Registry, where they are available to those who wish to deal with the company, who may also have no specific knowledge of the background to the adoption or alteration of the articles. For these reasons, and in contrast to the approach when interpreting ordinary commercial contracts, the relevant background facts for the purposes of interpretation of articles of association must be very limited.”

The case has sparked a considerable amount of interest as the BVCA documents are so widely used by investors in growth and venture capital. But, the real moral of the story is to be alive to any potential for conflict and deal with it expressly. 

Judgment: DnaNudge v Ventura Capital