Securities litigation: Shareholder claims post Covid-19

United Kingdom

Introduction

Prior to the Covid-19 crisis the UK was already seeing an uptick in claims brought by shareholders against companies and directors.

In particular, there have been a number of high profile class actions brought by shareholders in UK publicly listed companies based on claims that the company and its directors made false and misleading statements to shareholders to induce them to invest in the company or to approve substantial transactions which did not bring the returns that were anticipated. The UK courts have accommodated the bringing of class actions (whether pursuant to a Group Litigation Order or otherwise) and there are now well established claimant law firms, backed by third party funders, who can quickly mobilise to present claim opportunities to shareholders on a largely “risk free” basis. Securities litigation has been big business in the US for many years and the UK market is following suit.

The Covid-19 crisis is likely to see the trend in shareholder claims continue. Where companies have suffered a significant financial downturn during the crisis, claimant law firms and shareholders will be analysing whether any claims can be brought against the company or directors. Coming out of the crisis, companies may be looking to raise funds via rights issues or similar transactions with shareholders which brings with it the risk of claims based on misleading statements made to shareholders.

In this article we explore the types of claims typically available to shareholders and some of the key legal issues that arise based on our experience together with some practical considerations.

Typical Claims

The types of claim available to shareholders will vary based on whether the company is public or private:

Type of claim

Applicable to public or private companies

Brief description

Direct claims by shareholders

Section 90 of the Financial Services and Markets Act 2000 (FSMA)

Public only

Section 90 provides a cause of action in relation to untrue or misleading statements in listing particulars. This extends to omissions as well.

We explore this further in the sections below.

Section 90A of FMSA

Public only

Section 90A provides a cause of action in relation to a misleading statement in certain published information issued by a public company. This extends to omissions and dishonest delay in publishing information.

We explore this further in the sections below.

Claim for breach of common law duty to take reasonable skill and care when making statements to shareholders

Public and Private

Directors may owe a common law duty to shareholders to exercise reasonable skill and care when making statements to shareholders or when recommending a course of action for the company.

Claim for misrepresentation (negligent or fraudulent)

Public and Private

This can be an action in tort or an action under the Misrepresentation Act 1967.

Claim for breach of contract

Public and Private

Shareholders may be able to bring a claim for breach of contract (eg a shareholders agreement).

Derivative claims by shareholders on behalf of a company

Breach of directors’ duties

Public and Private

Directors owe various duties to a company and a breach of the duties can result in a claim by the company against the directors. Shareholders can pursue such claims by bringing a derivative action on behalf of the company. For further details on directors’ duties please see the CMS Guide for Directors of Companies, which has been updated to reflect the impact of Covid-19.

Directors’ liability under section 463 of the Companies Act 2006

Public and Private

Directors can be liable to a company in relation to an untrue or misleading statement made in (or an omission from) any of the following:

  1. the directors’ report;
  2. the strategic report;
  3. the directors’ remuneration report; and
  4. any separate corporate governance statement.

This liability only arises if the directors:

  1. knew the statement to be untrue or misleading; or
  2. were reckless as to whether the statement was untrue or misleading; or
  3. knew any omission to be a dishonest concealment of a material fact.

Class actions: Sections 90 and 90A FSMA

Of the above causes of action, a growing trend in shareholder claims are class actions based on sections 90 and 90A FSMA. These provide shareholders in a public company with a cause of action where misleading/untrue statements are made in:

  • listing particulars (section 90); and
  • other information published by a public company (section 90A).

Section 90 and 90A liability applies, amongst others, to issuers of securities traded with their consent on the main market of the London Stock Exchange or AIM. The liability is not limited to whether what is said is untrue or misleading but also extends to omissions of relevant information. In the case of section 90A, the liability also extends to a dishonest delay in publishing information and can apply to an UK issuer in relation to securities listed on, for example, the New York Stock Exchange.

The interaction of sections 90 and 90A can be seen as follows:

  • When a company issues securities for the first time or as part of a further round of capital raising and provides a listing particulars – section 90 is applicable in relation to misleading/untrue statements or omissions of information required to be included in the listing particulars.
  • Once the securities are issued and trading, for example, on the London Stock Exchange or AIM, the issuer’s liability operates under section 90A in relation to subsequent information published by it (e.g. its quarterly or annual accounts).

Common issues

The following are key issues that typically arise in relation to claims under sections 90 and 90A FSMA. There have been few reported cases in relation to these claims and so a lot of these issues are untested. However, there are an increasing number of claims being pursued under these provisions and so there will be opportunity for the English court to clarify the law:

  • Party to be sued: A section 90 claim can be brought against any person responsible for the listing particulars including the issuer, its directors and those stated as accepting responsibility for the listing particulars. A section 90A claim can only be brought against the issuer.
  • Primary and secondary market purchases: There is little doubt that a person who first acquired the securities will have a claim under section 90.However, it remains to be seen whether this protection will be extended to subsequent purchasers of the securities. It seems likely that where any inaccuracies in listing particulars remain “live” at the time of the secondary purchase then a claim could be brought. In contrast, liability under section 90A is available to all persons who acquire, continue to hold or dispose of the securities in reliance on published information. This extends to a person who acquires or disposes of any interest in securities or contracts to acquire or dispose of securities or of any interest in securities, depositary receipts, derivative instruments or other financial instruments representing the securities. As such the protection under section 90A will be available to, for example, intermediaries who are holding securities as custodians.
  • Knowledge: In relation to section 90 claims there is no requirement for dishonesty or knowledge that the listing particulars contain misleading/untrue statements or omit relevant information. However, it is a defence to a claim under section 90 to show that that there was a reasonable belief that the statement complained of was true and not misleading or that the omission was justifiable in the circumstances. In relation to section 90A claims, a key requirement for establishing liability is knowledge. The issuer is liable where there is an untrue or misleading statement and a person discharging managerial responsibilities (PDMR) within the issuer knew the statement to be untrue or misleading or was reckless as to that fact. In respect of omissions and delay in publication of information, liability arises where the PDMR knew the omission was a dishonest concealment of a material fact or acted dishonestly in delaying publication of information.
  • Reliance: In order to establish liability under section 90 there is no requirement for reliance on the untrue/misleading information. However, section 90A liability does require the person bringing the claim to show reliance on the untrue/misleading statement and that it was reasonable for that person to rely on the statement being complained of at the time and in the circumstances applicable. As such the statement should not be considered in isolation and this can be an important factor when defending such claims, particularly in the context of market uncertainty caused by Covid-19.
  • Causal link: The language of both sections 90 and 90A refer to the phrase “as a result of” when determining when the loss being claimed is linked to the relevant liability. How far this extends to limit liability is yet to be tested in the English courts.

Damages

Another important and yet untested aspect of sections 90 and 90A claims is the methodology for quantifying the loss that would be subject to compensation.  This is likely to be a fertile ground for defendants to explore to minimise the impact of any liability that can be established. Conceptually English law is not as a generous as, for example, the law applicable in some states in the US.  English law measures loss on a compensatory principle as opposed to allowing punitive and non-pecuniary loss by default.

There are various approaches to assessing damages, some of which might require expert evidence and complex questions around valuation of shares in counter factual scenarios:

  • One approach to measuring loss involves looking at the price at which a person acquired the securities and comparing that with the value of the securities following the revelation of the untrue/misleading statement. An issue that can arise in this context is the cut-off point for measuring the post-revelation price. With publicly traded securities, once investor confidence is shaken the share price of a company can go into free-fall. It is arguable that the “cut-off” should be the point at which the revelation was made because any subsequent drop in price is a function of a free market.
  • An alternative way to measure loss can be to identify the value of the securities as if the untrue/misleading statement had not been made.This can then be compared with the price paid for the securities and the differential would reflect the loss payable.
  • Alternatively, the calculation could involve the difference between the price paid and the re-sale value.

As can be seen from the above, there are various potential approaches which can give rise to complex calculations and significant scope for argument. Market circumstances can also have an impact on the recoverable loss. Take, for example, the following scenario: a statement is made by a publicly traded hospitality business that it has a substantial contract for providing exclusive catering for all wedding venues in London from April 2020 for 3 months.  Although the contract has no minimum guaranteed revenue the estimated profits are going to be over 50% of the company’s profits from last year. This statement was false and no such contract had been concluded. This could give rise to liability. However, in the current market where Covid-19 has resulted in the shutting down of wedding venues in London it would likely be argued that even if the statement had been true the company would be in no better position. Whilst this is an extreme example, it shows that market conditions will likely be a relevant factor in assessing any counter factual for the purposes of calculating loss.

Conclusion and practical considerations

Shareholder claims in the UK were on an upward trajectory prior to the Covid-19 crisis. In relation to public companies, sections 90 and 90A of FSMA are now commonly used to bring class actions as a result of alleged false and misleading statements. In relation to private companies, shareholders have various types of claim available to them including derivative claims on behalf of a company against directors.

As we emerge from the crisis, we can expect that upward trend in shareholder actions to continue. Companies and boards of directors should ensure:

  • All public statements or other communications with shareholders are properly verified and accurate.
  • Where advisors or other experts are responsible for the content of statements, this should be made clear.
  • If inaccuracies in statements to shareholders are identified, these should be corrected as soon as possible. Where possible, the company should keep a record of what led to the previous statement being made and any evidence to support the position that it was reasonable to have made the statement at the time it was made.
  • Written records should be kept of key decisions taken by directors and professional advisors and the reasons for them.Claims are likely to come to court a number of years after the events in question and having a complete documentary record of contemporaneous decisions that are taken can be very helpful in defending claims.
  • Comprehensive insurance coverage should be maintained whether specifically for public offerings or more generally for directors and officers.
  • If a company becomes aware of potential grounds for shareholders to pursue claims, an active damage limitation/risk management strategy should be developed rather than being reactive to a claim.
  • All communications and internal investigations in relation to the subject matter of potential claims by shareholders should be carefully managed, particularly with regard to whether legal professional privilege can attach to such communications and work product. This can be fertile ground for exploitation by claimants seeking disclosure of copies of documents relating to such investigations to help support their claim.