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price that issuers can achieve for the securities issued. If the risk of defective issues is to be borne by a subsequent buyer, subsequent buyers will price that risk and reduce the price they would otherwise be happy to pay for securities accordingly. This will also have a knock-on effect on the price the issuer achieves when securities are first issued. Because it is unknown to the market which securities are subject to equities, the market will discount all issues.

A rule allowing an issuer to enforce equities against subsequent buyers increases the cost of capital market-based finance. This should not be the case; in an ideal world the price of a security is entirely determined by an evaluation of the risk and the potential of the issuer’s business. The rules governing transactions should not create a cost that negatively affects security prices. In order to avoid transaction cost, and to increase the efficiency of the securities transfers, legal systems have developed techniques that insulate buyers of securities against equities arising from defective issues.

English law has developed two mechanisms for protecting the market against equities arising out of a defective allotment. Both are shaped path-consistently by the legal techniques available to English private law. The first is novation and the second is estoppel. They will be examined in turn in sections 5.2–5.4.

5.2 Novation

The conclusion of section 2.1 was that the historic starting point seems to have been that securities were transferred by way of novation. Transfers originally involved an explicit admission by the issuer of the transferee; the transferee was, therefore, insulated against equities arising out of the contract between the issuer and the transferor. Her contract with the issuer was independent of the relationship that existed between the issuer, the transferor and any other investors who held securities before her.

We need to ask ourselves if we can continue to apply this analysis today how the transfer procedure has changed. The first change was brought about by the arrival of free transferability. When securities became freely transferable, the issuer became obliged to register transfers either by virtue of a provision to that effect in the issuing documentation or by a change in the default rules set up by the Companies Act. The existence of an obligation to register transfers does not in and of itself affect the transfer process; transfers of transferable securities

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may, in principle, still be analysed in terms of novation. Novation, however, requires the consent of the issuer to create a new and independent relationship with the transferee.1 The novation analysis, therefore, can continue to apply only if the transfer process continues to involve a contractually binding statement on behalf of the issuer.

It is conceivable that companies which issued transferable securities at first continued to take securities transfers to the board of directors and to have board decisions resolving to admit transferees. It those circumstances there is no difficulty with classifying the board decision as the issuer’s consent to creating a new and independent relationship with the transferee. It is also possible for issuers to organise the transfer process so that the board delegates the authority to admit transferees to the secretary or an employee. The person so authorised would then act as an agent for the issuer and in that capacity consent to the novation.

Over time, however, a distinct act of admission seems to have disappeared. Lord Halsbury observed at the beginning of the twentieth century that ‘the corporation is simply ministerial in registering a valid transfer and issuing fresh certificates’.2

The problem of squaring the historically determined legal analysis with modern transfer procedure arises to an even greater extent when shares are issued and transferred in uncertificated form. With USR 2001, the issuer register has ceased to be of legal significance for transfers of uncertificated securities, as we saw in chapter 3. The Operator register now constitutes prima facie evidence of legal title to uncertificated securities. It would, of course, be possible to argue that the CREST maintains the register as an agent of the issuer and in that capacity admits transferees. CREST, however, does itself not explicitly admit transferees. Transfers of uncertificated securities are automated; the Operator register is amended in response to electronic instructions and it is difficult to see how this process could be analysed in terms of novation.

The registration of a transfer has been transformed into a simple administrative process. Current transfer practice has stopped containing an element of explicit consent aimed at creating a new and independent contract with the transferee. We need to ask ourselves, therefore, if we can continue to address securities transfers through the law of novation.

1Guenter Treitel, The Law of Contract, 11th edn. (London: Sweet & Maxwell, 2003) 673.

2Sheffield Corporation v. Barclay [1905] AC 392 at 396.

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The courts are, unfortunately, silent on this point. There is no authority explicitly stating that the registration of the name of the transferee of transferable securities would amount to a novation of the issuing contract.

5.2.1 Novation by operation of law

One way of upholding the traditional analysis would be to conclude that the statutory rules requiring the company to register a share transfer provide for a novation by operation of law. Under CA 1985, s. 14, the memorandum and the articles bind the company and its members to the same extent as if they had, respectively, been signed and sealed by each member. This provision, however, does not indicate the process through which membership is transferred to a new member.

Another provision to consider in this context is CA 1985, s. 182, which states that shares are transferable in the manner provided by the company’s articles but subject to the Stock Transfer Act 1963. Under CA 1985, s. 183 (1), it is not lawful for the company to register a transfer of shares unless an instrument of transfer has been delivered to it. CA 1985, s. 183 (5) requires a company which refuses to register a transfer to notify the transferee within two months after the date on which the transfer was lodged. It is difficult to see how the language used in these provisions could be construed as providing for a novation of the membership contract by operation of law. The rules, it seems, are concerned with the administration of share transfers rather than with the legal nature of the transfer process.

The last – and, perhaps, most promising – statutory rule is CA 1985, s. 22. That provision, as we have seen, states that ‘a person who agrees to become a member of a company, and whose name is entered in its register of members, is a member of the company’. The wording of the rule suggests that there is some contractual element to the transfer of shares.

CA 1985, s. 22 (2), however, refers only to the agreement of the transferee to be a member of the company. It does not suggest that upon registration the company is deemed to have agreed to a new and independent relationship with the transferee. The provision altogether refrains from classifying the legal nature of transfers of shares; it certainly does not suggest that registration amounts to an extinction of the membership contract with the transferor and the creation of a new membership contract with the transferee.

There also exists an explicit provision in the Companies Act 1985 stating that the shareholders’ register provides only for prima facie evidence

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of the shareholder’s entitlement.3 It seems that there is no alteration of existing rights, or creation of new rights based on entries in the register.4 There is, therefore, no obvious statutory basis supporting the proposition that a share transfer amounts to a novation by operation of law.

5.2.2 Novation by contract

Alternatively, it is possible to revert back to analysing transfers in terms of contract law, by propounding the argument that the company, when adopting its issuing documentation, has two alternatives in relation to securities transfers. The company can opt to have articles that restrict transfers, or it can decide to adopt the statutory default position whereby shares are freely transferable. If the company chooses to issue freely transferable shares it thereby agrees to all the transfers that will occur in the future.

Putting the argument in terms of contract law, the company would, upon incorporation, make an offer to all future transferees to accept them as shareholders provided that they are able to produce the documents necessary to have their name registered. The membership contract would then be novated when a transferee applied to the company to have her name registered and lodged the necessary documents with the company. This application would amount to an acceptance of the standing offer contained in the company’s articles. The same analysis would apply if shares were issued in uncertificated form. In the case of uncertificated shares, the electronic application of the buyer to have the shares transferred into her name would be classified as the acceptance of the offer contained in the issuer’s underlying documentation.

A similar scenario arises in the context of credit card transactions. There, the credit card company enters into two agreements. The first is concluded between the credit card company and the retailer: the credit card company agrees to pay all debt owed to the retailer arising out of card transactions. The second is concluded between the credit card company and the customer: the customer promises to pay to the credit card company all debt that arises out of her using the credit card. Whenever a customer and a retailer enter into a sales transaction and the customer pays by credit card, the debt arising out of the sales

3CA 1985, s. 361; CA 1985, s. 186.

4D. Frase, ‘Dematerialisation and Taurus’, [1991] Butterworths Journal of International Banking and Finance Law 73.

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contract is extinguished and two new obligations arise. The first arises under the agreement between the credit card company and the retailer and obliges the credit card company to pay an amount equivalent to the purchase price but reduced by the transaction fee to the retailer. The second arises under the agreement between the credit card company and the customer and obliges the customer to pay an amount equivalent to the purchase price to the credit card company. This process whereby the debt under the sales contract is extinguished and replaced by other debt has been classified as novation.5

Credit card transactions are of interest here because when the sale transaction is carried out novation occurs without the retailer, the customer, or the credit card company explicitly agreeing to the extinction of one obligation and the creation of a new one. The respective agreement is contained in the underlying documentation which was signed by the parties when the credit card relationship was originally set up.

In the case of a securities transfer, a similar argument could be put forward. The argument would be that the issuer’s agreement to the novation would not be given upon each transfer, but was contained in the company’s articles or the contract underlying the bond issue. There is, however, one important difference. In the case of a credit card transaction there will be explicit terms in the agreement between the credit card company and both the retailer and the consumer. In the case of share transfers no such explicit terms exists.

Table A, reg. 23 to the Companies Act 1985 simply states that the instrument of transfer of a share may be in any usual form or in any form which the directors may approve, and shall be executed by or on behalf of the transferor. Table A, reg. 24 empowers directors to refuse to register transfers of unpaid shares or transfers of shares on which the company has a lien. There is no provision in Table A explicitly stating that upon registration the company terminates the relationship with the previous shareholder and enters a new contractual relationship with the transferee.

The consent to a novation of the membership contract would have to be inferred from the fact that the company issued transferable securities and carried out the registration procedure in relation to the

5Treitel, The Law of Contract 702; Customs and Excise Commissioners v. Diners Club Ltd [1989] 1 WLR 1196.