Introduction

In the recent case of Re Klimvest plc [2022] EWHC 596 (Ch), the English High Court (”Court”) ordered the winding up of a public company on a relatively uncommon ground - loss of substratum, i.e. – the abandonment of a company’s main object and purpose.

Background

Klimvest Plc (the “Company”) sold its business and assets in January 2019, following which its sole significant asset was cash reserves of approximately £8 million. Following the asset sale, Klimt Invest SA (the “1^st Respondent”), being the largest shareholder of the Company, sought for the Company to utilize its proceeds to make new investments rather than distribute the proceeds of sale to the shareholders under a liquidation.

Mr Eric Duneau (the “Petitioner”) sought an order that the Company be wound up under section 122(1)(g) of the Insolvency Act 1986, contending that it was just and equitable to wind up the Company as the purpose or substratum of the Company had come to an end. The 1^st Respondent opposed the petition, contending, inter alia, that the purpose, or substratum of the Company had not come to end on the basis that prior to the sale of its assets, the Company had in essence become an investment holding company, and its purpose could still be achieved through such investment.

Loss of substratum: The test

In Cotman v Brougham [1918] AC 514, Lord Parker explained that the question of whether or not a company can be would up for failure of substratum is a question of equity between a company and its shareholders. It was held that the Court would essentially considered the following factor in determining whether the loss of substratum ground was made out:

1.        The first step is to identify the Company’s main or paramount object or purpose.

2.        To succeed on the loss of substratum ground, it must be at least practically impossible for the Company to pursue its main object or event or create a like business to pursue the main object.

3.        Even if it were technically possible to pursue the Company’s main object, one should still consider whether the Company still intends to pursue that purpose or has abandoned it.

4.        Where the Court is satisfied that the subject matter of a business for which a company was formed has substantially ceased to exist, such that even if the large majority of shareholders wished to continue to carry on the company, the Court would still make a winding up order: Re Eastern Telegraph Co., Ltd. [1947] 2 All ER 104.

Has the Company’s main object changed?

In ascertaining the Company’s purpose, the Court held that the following materials were potentially relevant: 

·            The Company’s Memorandum of Association, being the starting point.

·            Materials available to all investors prior to investing, particularly in the case of public listed companies, such as the prospectuses, offering circulars and information memorandum.

·            Materials subsequently produced, as there may be some change or development that was widely known to investors that did not fundamentally change the main or paramount object or purpose.

·            Name of the Company.

Apart from documentary materials, the Court also found evidence from the following witnesses helpful in identifying the Company’s main or paramount object or purpose:

·         Small shareholders who had no direct connection to the Petitioner gave evidence that the Company’s new intended purpose was “a new and different story”.

·         Employees of subsidiaries of the Company, who were able to “provide helpful evidence as to the scope of the Company’s business, and the purpose for which it carried on business”.

On the facts, the Court concluded that rather than becoming an investment vehicle holding shares in its subsidiaries, the Company’s main or paramount object or purpose had not fundamentally changed, with a significant part thereof still being based upon the original cloning technology, and the other significant part thereof having at least some connection therewith, and being a complimentary development of the Company’s business, as operated through subsidiary companies that it controlled.

Decision

Having identified the Company’s main or paramount object or purpose, the Court went on to hold that the loss of substratum ground was made out for the following reasons:

1.        It had become impossible, or at least practically impossible for the Company to pursue its paramount object or purpose, given the sale of the Company’s assets and the particular nature of the business of the Company.

2.        Even if it could, the sale of the Company’s assets and the proposal to invest in promising technology companies were a very different venture. There was a “clear abandonment” of the pre-existing object or purpose of the Company.

3.        By turning the Company into a private investment vehicle, the Company proposed to embark upon a course of conduct fundamentally outside or different from what could fairly be regarded as having been within the general intention or common understanding of its members, such that it would be unjust and inequitable to require them, against their will, to continue to invest in the quite different and speculative venture that is proposed, and therefore just and equitable that the Company be wound up.

Key takeaway

Loss of substratum has been a quite uncommon ground in just and equitable winding-up, given its high threshold. This recent decision certainly has provided more clarity.

In view of the decision, majority shareholders of companies should be aware that abandoning a company’s previous activities and pursue a fundamentally different business model may risk the company being wound up.

It remains to be seen whether Hong Kong court would follow this decision or how similar actions would be addressed. If Hong Kong court adopts the English approach, it would definitely broaden the options available to minority shareholders who wishes to oppose attempts by those in control of the company to change its business fundamentally.