EIC Services Ltd v Phipps [2004] EWCA Civ 1069

A company issued bonus shares on the mistaken assumption that all existing shares were paid up and without proper shareholder authorisation. The Court of Appeal held the bonus issue void for common mistake, finding that section 35A of the Companies Act 1985 did not apply as shareholders receiving bonus shares are not 'persons dealing with the company'.

Facts

EIC Services Ltd (‘the Company’) made a bonus share issue on 15 December 1999, purporting to capitalise £136,179.45 from its share premium account and issue 99 bonus shares for each existing share held. The resolution assumed all 137,555 existing shares were fully paid and entitled to participate equally. However, 110,320 of those shares (issued to 16 shareholders in November 1999) were nil paid. Additionally, the directors proceeded without obtaining an ordinary resolution of shareholders as required by Regulation 110 of Table A, incorporated into the Company’s Articles.

The Appellant’s Position

Mr Lee Barber, who had subscribed for shares at £1.25 each after the bonus issue, argued the bonus issue was void due to these fundamental defects.

Issues

1. Whether the bonus issue was void for common mistake, given that the directors proceeded on the mistaken footing that they had power to capitalise reserves and that all shares conferred equal dividend entitlement.

2. Whether section 35A(1) of the Companies Act 1985 could validate the bonus issue by deeming the board’s powers free of constitutional limitations.

Judgment

Common Mistake

Lord Justice Peter Gibson, delivering the lead judgment, held that the bonus issue was void for common mistake. He approved the approach of Scott J in Re Cleveland Trust plc [1991] BCLC 424, where it was accepted that the relationship between company and shareholder in a bonus issue is analogous to contract, making principles of common mistake applicable.

“The subject-matter of the contract, for present purposes, was the issue of the bonus shares. It was fundamental to the issue that the dividend deriving from McInnes’s capital profit could be used in paying up the bonus shares. The true state of affairs… did, in my judgment, render essentially and radically different the subject-matter which the parties believed to exist.”

The Court found both defects were fatal. Without shareholder approval, the directors could only issue nil paid shares, fundamentally different from what was contemplated. The Bonus Issue resolution made clear that capitalisation and full payment were integral conditions.

“The resolution cannot be so construed. It was part and parcel of the resolution that the sum which was specified in the resolution and stood to the credit of the share premium account was to be capitalised and appropriated to the holders of the 137,500 shares in issue on condition that the sum was to be applied in paying up in full at par all the bonus shares.”

Section 35A of the Companies Act 1985

The Court held that section 35A did not apply because shareholders receiving bonus shares are not ‘persons dealing with the company’ within the meaning of the section.

“Having regard to the nature of a bonus issue… and the fact that it is an internal arrangement with no diminution or increase in the assets or liabilities of the company, with no change in the proportionate shareholdings and with no action required from any shareholders… I do not think that the shareholder is a person dealing with the company as a matter of ordinary language.”

The Court noted that Article 9(2) of the First Council Directive on Company Law, which section 35A implemented, protected ‘third parties’, which naturally refers to persons other than the company and its members.

Implications

This case establishes important principles regarding bonus share issues:

1. A bonus issue proceeds on fundamental assumptions that all participating shares are properly entitled to dividends and that proper corporate authorisation exists. Failure of these assumptions renders the issue void.

2. Section 35A protection for dealings with companies does not extend to shareholders receiving bonus shares, as this is an internal corporate arrangement rather than a bilateral transaction.

3. Courts will not sever a bonus issue resolution to preserve validity for some shareholders when the resolution fundamentally assumed equal participation by all.

The decision reinforces that technical compliance with company law requirements for bonus issues is essential, and courts will not readily cure defects that go to the heart of the transaction.

Verdict: Appeal allowed. The bonus share issue on 15 December 1999 was declared void.

Source: EIC Services Ltd v Phipps [2004] EWCA Civ 1069