A recent case in the High Court illustrates the incidental effect confidentiality obligations can have in reinforcing lock-in and deadlock provisions, such as restrictions on the right to transfer shares. If a shareholder in a joint venture company, for example, is thinking of selling its stake to an outsider, the shareholder is likely to concentrate first on the transfer provisions in the company’s articles of association or the relevant shareholders’ agreement, looking for ways to get round the often elaborate prohibitions on its right to deal with the shares. But any serious buyer is likely at an early stage to want information about the company going well beyond what can be read on the public file at Companies House. How can the shareholder safely disclose information to the buyer, especially if the shareholder has expressly agreed to keep the information confidential?
A robustly commercial approach can be tempting: if the information goes no further than the buyer, what harm is there? But in Richmond Pharmacology Ltd v Chester Overseas Ltd the court decided that a confidentiality obligation meant exactly what it said, and refused to read into it an implied licence to pass information to an outsider as long as the outsider treated the information as confidential.
The case concerned a pharmaceutical research company owned by its three founders and by an outside investor, which held 44 percent of the share capital. There was a shareholders’ agreement that allowed the investor to disclose confidential information to its professional advisers and bankers (as long as they kept it confidential), but otherwise required the investor to treat all commercially sensitive information about the company’s affairs as strictly confidential unless the board agreed to its disclosure. An initial lock-in period had expired, and shareholders were free to transfer their shares provided they first offered them at the same price to the other shareholders.
The investor decided it was time for exit. Hopes of a sale to the founders in an MBO came to nothing, and the investor engaged advisers to search for prospective buyers and disclosed information to the advisers for that purpose. Care was taken to ensure that any prospective buyer received confidential information only after the buyer had entered into a non-disclosure agreement.
In due course the founders discovered what was going on and the company took proceedings for breach of contract, arguing that the sale process had caused substantial loss of business for the company. The company also alleged that, to boost interest, the investor had misleadingly given buyers the impression that it could deliver the whole company, and that this in itself was in breach of the confidentiality obligations and had caused the company loss.
The investor argued that the shareholders’ agreement was being read out of context and that, on a proper commercial interpretation, the investor had been within its rights. Although the clause listed exceptions, such as disclosure to advisers and bankers, the investor said the list was not intended to be exhaustive. Nobody would be willing to buy a minority shareholding in a company of this kind without substantial amounts of detailed information about the company’s affairs, much of which would inevitably be confidential. The investor said its right to sell its shares (albeit subject to pre-emption) would be entirely illusory unless it could provide such information to a third party. The obligation was to “treat [the information] as strictly confidential”, and that, according to the investor, was not the same as a bar on divulging or communicating the information to any other person. It must follow that the contractual obligation to keep information confidential could be complied with by ensuring that the third party agreed to keep the information confidential.
But the judge said that, on the contrary, the ordinary and natural meaning of an obligation to treat information as confidential was that it could not be disclosed to anyone else unless expressly permitted. This interpretation was by no means contrary to business common sense. The need to approach the board for permission to disclose to third parties was reasonable in the circumstances. One should not jump to the conclusion that the board would behave arbitrarily, especially as the shareholders’ agreement contained deadlock provisions leading to winding-up as the ultimate recourse. The commercial reality was that it was always going to be virtually impossible for a person in the investor’s position to sell its shares without getting the prospective buyers to engage directly with the founders.
The judge also decided representations – even though they were untrue – that all the shares in the company were for sale were in breach of the obligation not to disclose commercially sensitive information to outsiders.
Although the investor was found to be in breach of the confidentiality obligations, the company was unable to prove that it had suffered any loss as a result. Nevertheless, if the circumstances had been different, the investor might have had to pay substantial damages.
The case stands in the way of those who argue that it is implicit that there will be no breach of confidentiality as long as there is a chain of undertakings between the owner of the information and the ultimate recipient. Non-disclosure agreements are often quite specific about the categories of third party to whom disclosure is permitted, such as advisers, other group companies involved in the transaction, and employees on a need-to-know basis. Most owners would be far from happy to think that their information could be disclosed with impunity to a third party whose only contractual duty was to the discloser, not the owner. The judgment is therefore welcome, as it promotes certainty.
The case is also a useful reminder to minority investors in private companies of the real practical difficulties of achieving an exit. In the absence of express agreement, it cannot be assumed that the company or the other investors will co-operate in facilitating a sale – especially where potential buyers are likely to be competitors. Confidentiality provisions can stop the process in its tracks.
James Grimwood is a partner and Sebastian Lea is a trainee at CMS. Mr Grimwood can be contacted on +44 (0)20 7367 3244 or by email: firstname.lastname@example.org.
© Financier Worldwide
James Grimwood and Sebastian Lea