DnaNudge v Ventura Capital GP Ltd Appeal
You may remember that in July I wrote about the High Court judgment in DnaNudge Ltd v Ventura Capital GP Ltd. On 9 October, the Court of Appeal upheld the High Court’s decision that a conversion of preferred shares (‘Series A Shares’) into ordinary shares upon notice from an investor majority (comprised entirely of ordinary shareholders) constituted an abrogation of the rights attached to those shares and that there was a fatal drafting error in the Articles which needed to be corrected by an implied term.
The Court of Appeal held that the High Court Judge was wrong to say that the significant premium paid for the Series A Shares constituted payment for the special rights attached to them, and to take that into account in his decision but, that the decision was right on other grounds.
The Court of Appeal considered various judgments on interpretation in contracts but concluded that Articles of Association differ from a regular contract:
‘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 Court of Appeal said that the Judge was entitled:
‘to investigate whether the rival meanings of Article 9.2(a) were consistent with the other provisions of the Articles and to ask whether they produced a coherent and commercially sensible scheme for the Articles as a whole. If there were issues in that respect, the Judge was entitled, if it could conscientiously be done, to adopt an interpretation that reconciled any potentially conflicting provisions in the Articles.’
The Court of Appeal agreed with the Judge that:
‘the Company’s contention as to the meaning of Article 9.2(a) would lead to an incoherent scheme and irrational results.’
The preferred share rights were carefully designed to apply in specific scenarios but if the Company’s argument was accepted:
‘Article 9.2(a) would give an Investor Majority comprising only Ordinary Shareholders, an unrestricted power to deprive the holders of the Series A Shares of the particular benefits conferred by those special rights at any time chosen by the Ordinary Shareholders.’
The Court of Appeal noted that to argue, as the Company did, that the ordinary shareholders could have served a conversion notice immediately after the Series A Shares were issued was:
‘a bizarre conclusion which makes no commercial sense given the very creation of the Series A Shares as a separate class and the detailed terms of Articles 5 and 6.’
The Court of Appeal went on to say that it was irrational of the Company to interpret Article 9.2(a) such that it:
‘could reasonably be foreseen to have the result that the special rights attaching to the Series A Shares would be inevitably extinguished by a conversion notice served by the Ordinary Shareholders in precisely the circumstance in which they were most obviously intended to operate to the benefit of the Series A Shareholders,’
‘There is no rational or logical justification for such a bizarre regime under which the holders of the Series A Shares would be protected by having to give a class consent to every lesser alteration of their rights, but would have no such protection in the event of a conversion in which their special rights would be entirely extinguished.’
The Court of Appeal concluded that:
‘These incoherent and irrational results are striking, and I agree with the Judge that they demonstrate convincingly that the construction of Article 9.2(a) advanced by the Company is not one that should be attributed to the members of the Company. Something has plainly gone wrong with the drafting.’
The Judgment went on to consider what was to be done about the drafting error:
‘If it is clear that there has been a drafting mistake in omitting a provision from a contract, without which the contract leads to incoherent and irrational results, and if it is equally clear what that missing term should be, it is not surprising that the test for implication of terms should also be satisfied. Paraphrasing Lord Neuberger in Marks & Spencer, the missing term would be necessary to bring commercial and practical coherence to the contract, and it would fulfil the requirements of clarity and obviousness.’
Having considered a further argument by the Company that no abrogation of rights would be involved in a conversion of the ‘Series A Shares’ shares and finding against the Company on the point, the Court of Appeal concluded that the Judge was right to reach the conclusion that in order to make rational and coherent sense of the Articles, either Article 9.2(a) must be interpreted as being subject to Article 10.1, or a term must be implied to that effect and the Company’s appeal was dismissed.