Wednesday, 15 October 2014

Enforceability of Shareholder Agreements in the DIFC: Smartpaper Software LLC v Keross LLC and Another

This case which came before Sir John Chadwick in the Court of First Instance of the Dubai International Financial Centre is of interest of practitioners outside Dubai because the enactments that the judge considered are modelled on Acts of the United Kingdom Parliament and the contract that the claimant company sought to enforce was one that could easily have been concluded by entrepreneurs anywhere.

In Smartpaper Software LLC  v Keross LLC and Another CFI 012/2010 14 Sept 2014 the claimant sued for damages for breach of a shareholders' agreement to which neither the claimant nor the first defendant were party. The agreement, which is described as a “Final and Binding Shareholder Agreement for Selling Membership Interests of Keross LLC” (the “first defendant”) for the stated purpose of working together in an orderly and transparent way to effectuate the sale of all membership interests owned by two parties to the agreement respectively to the second defendant, provided for the first defendant to transfer certain assets and liabilities to a new company to be formed. The claimant, which was incorporated 3 months after the shareholder agreement, claimed to be that new company. It alleged that the defendants had failed to transfer those assets and in particular certain contracts to it. The value of those contracts was the sum claimed in damages.

The action came on for trial before Sir John on 22 Feb 2012, He formed the preliminary view that the claimant was unlikely to succeed for the following reasons:
  1. The claimant was not party to the shareholder agreement.
  2. The first defendant was not party to that agreement.
  3. The proposed transfer was unlawful under art 46 of the DIFC Companies Law unless the case could be brought within one of the exceptions under art 46 (1).
  4. The particulars of claim no longer disclosed a cause of action as certain paragraphs alleging malice had been struck out by Sir David Steel shortly before the trial.
The judge invited the claimant to address him on those points before calling evidence. The claimant's representative, who was one of the parties to the agreement, failed to persuade Sir John who dismissed the claim under RDC Part 24 which appears to be modelled on Part 24 of the English and Welsh Civil Procedure Rules. The judge indicated that he would put his reasons in writing which were published on 11 Sept 2014.

In his reasons the judge modified his view on the first ground. The claimant relied on art 104 (1) and (3) of the DIFC Contract Law which is modelled on s.1 (1) of the British Contracts (Rights of Third Parties) Act 1999:
"104 Right of third party to enforce contractual term
(1) Subject to the provisions of this Law, a person who is not a party to a contract (a ‘third party’) may in his own right enforce a term of the contract if
(a) the contract expressly provides that he may; or
(b) subject to Article 104(2), the term purports to confer a benefit on him.
(2) Article 104(1)(b) does not apply if on a proper construction of the contract it appears that the parties did not intend the term to be enforceable by the third party.
(3) The third party must be expressly identified in the contract by name, as a member of a class or as answering a particular description but need not be in existence when the contract is entered into."
The shareholder's agreement provided:
“In consideration for Sami and Khaled selling their respective interests to Farouk, Keross LLC shall transfer the ownership of specific assets and liabilities (the ‘Consideration’) to a new legal company (the ‘New Entity’) to be incorporated by Sami and Khaled.”
At paragraph 11 of his reasons the judge said:
"It seems to me reasonably clear that the “New Entity” is a person on whom the relevant term purports to confer a benefit within the meaning of Article 104(1)(b) of the Contracts Law; and that it cannot be said – for the purposes of Article 104(2) – that the parties did not intend that that term should not be enforceable by the New Entity. It is also clear that SCS is not “expressly identified” in the Shareholder Agreement by name or as a member of a class for the purposes of Article 104(3). The question is whether SCS is expressly identified “as answering a particular description”: that is to say, whether SCS can be identified as the “New Entity”?"
The judge did not decide the point as the claim failed on other grounds. However, he said at paragraph 12:
"In the circumstances that I have reached the conclusion, on other grounds, that the claims advanced by SCS in these proceedings have no prospect of success and should be dismissed, I am content to assume (without deciding) that SCS can be identified as the “New Entity” for the purposes of article 104(3) of the Contracts Law."
Similarly, he made no finding on the second point as the particulars of claim  had alleged that the first defendant was party to the shareholders' agreement through the agency of their directors and shareholders. At paragraph 15 he said:
"Given that [the first defendant] has taken no part in these proceedings – and in the absence of any allegation of agency to support the assertion in the Particulars of Claim that it “came to an agreement” – I would be reluctant to hold that [the first defendant] must be treated as a party to the Shareholder Agreement. In the circumstances that I have reached the conclusion that, having regard to Article 46 of the DIFC Companies Law, the claims in these proceedings have no prospect of success, it is unnecessary to decide the agency point; and I do not do so."
However, he held that the transaction was unlawful having regard to art 46 of the Companies Law which prohibits companies from providing financial assistance to acquire shares in that company or its holding company unless the transaction falls within one of a number of exceptions. Further, as the parts of the particulars of claim alleging malice had been struck out there was no longer a cause of action.

Because the case was decided by a former Lord Justice of the Court of Appeal and the enactments are modelled on English statutes this case is of persuasive authority in the United Kingdom and other jurisdictions with similar laws. It is a pity that the judge did not decide the privity and agency points but he has uttered some useful dicta.  The issues raised in this case should be borne in mind by those who negotiate and draft shareholders' agreements in England as well as the DIFC,