Covid-19: suggestions for emergency law reform

Promoting fairness, spreading costs and avoiding a long tail of litigation

In my blog post of yesterday I described the existing law as it applies to business contracts during the coronavirus outbreak. I set out below some of the legal steps I think Government/Parliament should consider taking to stabilise the economy and markets and reduce unfair burden-sharing across the economy. It would normally be profoundly un-Conservative to interfere in private contracts, but in this case the circumstances were entirely unforeseen and the losses will be distributed in a way that is close to random, but with the effect falling particularly heavily on small businesses unable to pass costs back to their suppliers. Government attempts to help business with loans and other support are entirely welcome, but unless Government will contribute the entire cost to the economy, which is unlikely, it is important also to share the remaining burden across the economy as evenly and fairly as possible, and to preserve businesses and jobs so that they can resume after the crisis without a burden of debt or the threat of litigation. That needs to be done with very broad-brush temporary legal measures to complement targeted Government assistance.

English law currently makes no provision for short-term suspension of businesses or the temporary laying-off of workers. Businesses that do not perform contracts may be liable for unlimited claims for losses suffered by the other party.

My suggested steps are intended only to apply during the duration of the Covid-19 crisis. Ministers should take power to remove or suspend them when appropriate, with power to restore them if the virus returns. Inevitably they carry risks of further unfairness, fraud and abuse, but their short-term nature should mitigate that. Considerations of moral hazard (relieving those who did not prepare at the expense of those who did) hardly apply when the present situation was so unforeseeable.

All of my suggestions can be implemented by legislation alone, without of themselves requiring additional public expenditure, though for best effect they would be integrated with the financial measures already announced, or to be announced, by the Chancellor.

1.    For the duration of the crisis, businesses should be given power to “mothball” themselves, or individual sites or business activities within a company, without going to court or any other formality other than public notice. I would call this Suspension.

1.1. Suspension would have the same effect as Administration (Insolvency Act 1986 Part II) but the directors would remain in control and the process could be applied to an identifiable part of a business (such as a retail unit or a product line, with the employees, contracts and assets relating to that unit being deemed to be those of the unit in Suspension as if it were a separate company). Suspension would be permitted only if the directors consider the business to be uneconomic during the crisis and for the sole purpose of preserving the business during the crisis.

1.2. During Suspension, no debts or contracts incurred before 16 March 2020 or accruing under existing obligations could be enforced by legal action or appointment of liquidators/administrators. Employment contracts could not be terminated but employees could be laid off at a specified rate – SSP rate, half pay, 75% or full pay, depending on Government subsidies. Government would undertake to pay all or a proportion of these wages costs, and could provide loans pending later claims. This could be extended to zero-hours workers and contractors engaged direct or through service companies. Alternatively, laid-off workers would be entitled to state benefits during lay-off as if unemployed, but without obligations to seek work.

1.3. Rents and interest payments and accruals could be arbitrarily reduced by 25% or 50% during the peak crisis period, sharing burdens with landlords and lenders, depending on how Government subsidies are to be targeted. Services provided to or by the busienss (other than utilities) could be suspended notwithstanding any long-term contracts, and no payments would be due for services not provided.

1.4. At the end of Suspension, the business would have to pay its suspended debts (but not cancelled interest, rent or taxes) no later than equal monthly instalments over six months.

1.5. Public service obligations could be imposed as conditions of Suspension, such as contributing to initiatives to provide essential products or services, or making staff available for volunteering, or a general obligation of directors to do everything possible to support public initiatives to fight the virus and keep the economy going.

2.    Alternatively, or as a separate initiative, employers should be given power to lay off employees on short notice for up to three months or the duration of the crisis, continuing to pay them (at reduced rate as above) with the benefit of state subsidies. Existing redundancy processes are too slow (for large businesses consultation and selection for redundancy plus notice period would exceed the likely duration of the crisis) and result in permanent dismissal. Anyone made redundant on or after 16 March 2020 and for the duration of the crisis should be automatically entitled to reinstated within six months unless the employer goes bust or can show that the job was redundant notwithstanding the crisis. This is what Virgin Atlantic is trying to achieve, but without a change in the law, its initiative would not survive challenge in the Employment Tribunal.

3.    All commercial rents and/or trading company interest rates in force between private parties at 16 March 2020 could be reduced by 25% for three months, purely as burden-sharing, on top of any reduction due to the base rate cut. Financial markets would need to be exempted in view of international implications and there might be a size threshold, though it would be a mistake to assume that only small businesses need relief.

4.    Covid-19 should be deemed a “force majeure” event for all contracts (other countries, eg China, have done this); the law would imply a term into every contract governed by UK law that if performance of the contract is rendered impossible, impractical or uneconomic by the coronavirus crisis (including by labour shortage or unavailability of supplies) the obligation is suspended, if capable of being performed later, or cancelled if time-critical, with any advance payments or expenses being refunded (as per section 2 of the Law Reform (Frustrated Contract) Act 1943), plus consumer deposits or prepayments being refundable in full. This would not apply to financial markets or insurance contracts but could apply to bank lending. This is intended to prevent the economy being overwhelmed by a tide of litigation attempting to shift costs to other parties and breach of contract claims for damages, including for loss of profit. Legislation akin to the Protection of Trading Interests Act 1980 could be used to prevent British companies being victims of such claims abroad or under contracts governed by foreign law.

5.    Compliance with Government recommendations on public health should be deemed compliance with a legal obligation for the purposes of all contracts and the law of torts, so that no-one can be sued for doing so and compliance, by the business or third parties, provides a lawful excuse for non-performance of obligations and enables insurance and benefits claims. No-one should be penalised for acting in accordance with Government advice, or because it is advice rather than the law.

6.    Legislation should say that exposure to coronavirus in the course of normal working should not in any circumstances be deemed a breach of health and safety laws by employers or negligence by the operators of business or premises. Otherwise businesses which should be staying open, perhaps in essential sectors such a heath supplies or food distribution, will close down because of the duties they have towards their own staff and the public, and will be reluctant to re-open as the danger reduces. We need to be explicit that businesses and individuals are allowed to take some risk in order to combat the virus and keep the economy going. Employers are reacting as if the call to work from home means that all workplaces must be closed, whether or not home working is possible. We do not want courts examining decisions with the benefit of hindsight, or businesses being burdened with litigation as they try to recover.

7.    Loans made under Government crisis initiatives should be exempted from prohibitions in other contracts and from calculation of financial covenants in bank lending documents. Otherwise acceptance of such emergency loans is likely to amount to a default under existing loans and result in lenders enforcing security, appointing administrators or increasing interest rates and fees to penal levels. There is a danger of lenders seeing receipt of crisis subsidies as an opportunity to recover pre-existing debt. It would be possible to suspend all financial covenants in loan agreements for a period to prevent defaults.

8.    Ministers should take powers to disapply intellectual property rights during the crisis if they restrict business responses to the crisis, eg by inhibiting UK copying and production of ventilators or other essential supplies normally sourced from overseas.

9.    The EU should suspend all State Aid restrictions during the crisis (at least outside the Eurozone) and disapply competition law to the extent that it inhibits businesses co-operating for the efficiency of the economy and the sourcing and distribution of goods during the crisis.

In the absence of steps such as these, businesses will take their own steps to protect themselves and (as they are required by law to do) their creditors and employees by making staff permanently redundant, disposing of assets (eg by not renewing leases) and/or going into insolvency, doing permanent damage to the economy and having knock-on effects for creditors and the wider economy. An overhang of litigation could stifle the economy for years to come. 

Stay safe.

Covid-19: who bears the loss? Contracts and Coronavirus

All the news is about Coronavirus and its dangers to people, society and, in third place, the economy. As well as human tragedies, we are facing unprecedented disruption to work and economic activity. We could be facing an unprecedented wave of bankruptcies. But where will the losses fall?

Supply chains and back-to-back contracts

Supply chains and labour markets are complex and often unstructured, and in many cases the effects of Covid-19 losses will be close to random. Businesses may be fighting for survival, and anxious to pass on costs and losses to other parties. Consumers will want their money back for goods and services they can’t use. Demand has fallen, in many cases to levels at which it is uneconomic to continue. Wages and business costs continue to accrue. Suppliers still want to deliver and be paid.

It can come as a huge shock to a business to find itself bearing the loss of the entire supply chain because it is a man-in-the middle, due to mismatches in contract terms. Purchase orders can’t be cancelled unless the contract terms allow that, even if customers cancel their orders or refuse delivery. Consumers may have rights to cancel, return goods or just fail to pay, but a retailer may not be able to pass the cost back up the chain. The loss will often fall at the retail level, because consumers have legal rights (cancellation, returns, refunds) that retailers must respect; trade contracts up the chain will not usually give the buyer the same rights. International contracts may be worse still, with different laws and legal systems applying to each link in the chain.

Imagine a small travel agent, putting together its own packages for holidaymakers on a modest margin: it may have committed to hotels and airlines, or even paid them in advance, but when the FCO advises against travel, or the destination closes borders, the customers will be entitled to their money back. The agency’s contract with the suppliers may not entitle it to a refund, leaving the agency with the full liability. In an ideal world, supply chains are built with back-to-back contracts and pay-when-paid clauses that allocate the loss appropriately across the supply chain, or to parties who are insured, but that is the exception rather than the rule. Often the loss will fall on the weakest link in the chain, the person who has not been able to negotiate let-outs with either its customers or its suppliers.

Frustration

What remedies does the law allow when a performance of a contract becomes impracticable? Is a party liable for breach of contract if he simply cannot comply?

If the contract terms provide no let-out (such as an express cancellation right, or an implied right to terminate and indefinite contract on reasonable notice), the only legal escape is the legal concept of frustration. A contract is frustrated if something happens after the date of the contract has been formed that is not the fault of either party and is so fundamental that it strikes at the root of the contract and is beyond what was contemplated by the parties when they entered into the contract. It must render further performance impossible or illegal, or make the obligations radically different from those contemplated by the parties at the time of the contract. Frustration brings the contract to an end immediately, and relieves both parties of any unperformed obligations. Under the Law Reform (Frustrated Contracts) Act 1943, money already paid is normally recoverable, less any expenses incurred by the other party. A party who has gained a valuable benefit under the contract must pay a just sum for that, and a party who has incurred expenses may charge them to the other party. 

Circumstances arising from Coronavirus are certainly capable of amounting to frustration. If it became illegal to ship goods across a border, or particular workforce could not travel or was incapacitated, or an asset (such as hotel or ship) was requisitioned or closed down, that could frustrate a contract specifically relating to that, and applying in the short term. Because frustration ends the contract completely, it cannot help if all that is needed is a temporary suspension or delay. The performance of the whole contract must be completely impossible or radically different to what was expected. The contract is not frustrated just because it becomes more expensive or inconvenient to perform, or if there is another way of performing it, or if it cannot be performed due to a risk that should have been contemplated by the parties, such as supplier failure. There is no frustration if the purpose, rather than the performance, of the contract, is impossible: for instance, the European Medicines Agency’s 25-year lease of its London headquarters was not frustrated by Brexit (Canary Wharf (BP4) T1 Ltd v European Medicines Agency [2019] EWHC 335 (Ch)).

A particular issue arises (at the time of writing) from the UK government’s approach to the social distancing measures required to fight Covid-19. The Government is acting by making strong recommendations, rather than imposing legal banks on events or activities. That means compliance is voluntary, so the advice is unlikely to frustrate contracts. A party complying with the advice, or who cannot perform because his employees or suppliers are complying, risks being sued for breach of contract, or forfeiting his advance payments. Not only will that cause losses to consumers (who may not be able to get refunds for holidays, event tickets etc, and may be sued by desperate businesses unable to fill vacancies), but this could be detrimental to the essential public health objectives. Venues will be tempted to stay open and events to go ahead so as to avoid paying refunds or being sued for failing to deliver promised goods or services, and the public will be tempted to go ahead with activities they have already paid for.

Employment contracts are unlikely to be frustrated, except in the sad event of the death of the employee. Employers will still have to pay salaried staff who are ready and willing to work and will continue to have an obligation to provide paid work for other staff. It seems that employees self-isolating will be deemed to be sick, at least for the purposes of statutory sick pay, though it is not clear whether that relieves employers of paying more generous contractual sick pay, or full pay for salaried workers, who are not in fact sick. Emergency legislation has made statutory sick pay payable from day 1.  There is no automatic right to suspend or stop paying staff if workplaces are closed or customers stop buying. Not all contracts provide for short-time and lay-offs. Cuts to the workforce will have to follow usual redundancy procedures, including consultation, selection and payment of notice pay and redundancy compensation.  Employers will be looking for other cost saving measures that can be implemented swiftly. On the day of writing, Virgin Atlantic has invited its staff to take eight weeks of unpaid leave or face mass redundancies; many workforces would not agree to that, but some may feel that they have little option to keep their jobs when others are unlikely to be recruiting. They are unlikely to qualify for most state benefits if still employed but on unpaid leave. The cost of redundancies could well be as great as paying wages through the crisis, depending on how long it lasts. Further emergency legislation is likely in this area.

Force majeure

Many contracts (including standard terms of business) contain “force majeure” clauses. They usually relieve the parties from performing obligations if they cannot be performed for specified reasons beyond the parties’ reasonable control. They may suspend performance for a period, and/or allow the parties to terminate the contract without liability on either side. Labour shortages, transport disruption or supplier default may (or may not) be listed as a force majeure event, though it would still have to be the main cause of the disruption and outside the party’s control. Whether a public health emergency amounts to force majeure depends on the wording of the clause. 

The situation must still be beyond the control of the affected party. Again, the fact that compliance with Government advice is voluntary might not help to bring the situation within the force majeure clause. Inability to pay money due to loss of income will not be force majeure; nor will obligations that are just more expensive or difficult to carry out, but are not impossible.

Often there are formalities needed to invoke the force majeure clause, such as giving notice to the other party, or taking steps to mitigate the effect of the event. Unlike frustration, force majeure may apply to the obligations of one party only, and can grant a temporary suspension or delay. On the other hand, the presence of a force majeure clause may mean that the contract is not frustrated: if the agreed terms deal with a situation, that situation will not frustrate the contract.

The cost

The main impact of Coronavirus is the large number of human tragedies. Economic considerations are less important, but the economy also has real effects on keeping people alive and safe. The damage will be spread throughout the economy, but the losses will not be even and will not fall fairly, especially if governments do not intervene. Some individuals and some businesses will suffer disproportionate pain. The English law of frustration and force majeure is not going to help significantly in restoring order or fairness in this crisis. Ultimately, much of the economic cost may be felt through business failures and job losses. Insolvencies result in real and permanent damage, even if new businesses, or phoenix businesses, eventually arise from the ashes to provide the same goods and services. Innocent employees, business owners, shareholders and pension fund members will bear the cost.

Things are changing fast – this article is written on 17 March 2020. Further emergency legislation is very likely – it may include new ways for businesses to suspend or reduce activities.

Stay safe.

First disqualified director compensation order

Banned directors can now be made to pay creditors

A director has been ordered to pay over £500,000 in compensation to creditors of a company who suffered from his misconduct, as the first compensation order made under the director disqualification regime. Where a disqualification order has been made, the director can now be ordered to compensate creditors, even if the liquidator is unable or unwilling to pursue the director.

The Secretary of State has to make the application, so the number of cases is likely to be limited by the resources of the Insolvency Service. But in egregious but otherwise hopeless cases, where insolvency practitioners probably have no funding to purse director claims, this provides a new route for creditors to make recoveries. It may become routine for compensation to be considered when disqualification proceedings are brought. Where a director gives a disqualification undertaking to the Secretary of State instead of being taken to court, a compensation undertaking can also be sought.


Published guidance on compensation orders indicates that the Secretary of State will not seek compensation orders if that would compete with claims actually being made by the liquidator or administrator. Distribution of funds can either be via the Secretary of State or by payment to the company for distribution by the liquidator.

In this case, Secretary of State v Eagling [2019] EWHC 2806 (Ch)., relating to wine investments, the director paid all the company's cash to an associate of his and fled to Northern Cyprus. He was disqualified from acting as director or being involved in business management for 15 years and ordered to pay compensation of £559,484. The court and the Secretary of State were able to direct the compensation to benefit the creditors most directly affected by the misconduct, rather than the money going into a general pool. 

Bank liability for fraud

Negligent bank responsible even if payments are authorised per the mandate

The Supreme Court has affirmed a decision that a bank is liable to refund a customer for a fraudulent transaction otherwise properly authorised in accordance with the bank mandate, if the bank was negligent in not recognising and blocking the fraud - the "Quincecare" duty: "the bank should refrain from executing an order if and for so long as it was put on inquiry by having reasonable grounds for believing that the order was an attempt to misappropriate funds."

In this case the company was being defrauded by its own controlling director, and it is hard to see what the bank could actually have done without risking being sued for not carrying out the director's instructions.

This case potentially opens the door to thousands of claims by victims of "push payment" frauds if they can show that the bank was negligent in accepting the customer's instructions.

Singularis Holdings v Daiwa Capital Markets

Dangers for nominee directors - and those appointing them

Directors' responsibilities in sharp relief, and a piercing of the veil of limited liability?

There may be nothing new in the idea that a nominee director must exercise independent judgement and act in the interests of his own particular company, rather than the interests of a parent company or the person appointing him, but Central Bank of Ecuador v Conticorp SA provides an eye-watering illustration to make nominee directors sit up and think!

A Mr Taylor, acting as nominee of a banking group, was the sole director of a Bahamas company. He acted only on the instructions of the banking group, and was paid the princely sum of $2,500 a year for acting as director. On instructions, he signed away a portfolio of assets worth $190m in a transaction at an undervalue. He made no enquiries as to the commercial benefit to his company of the transaction, and did not exercise any independent judgement. Because of that, he was fixed with the knowledge of the nature of the transaction of those instructing him. He was found personally liable for the whole $190m, plus interest that took the claim over $1/2billion.

That can easily happen when someone takes the office of director without taking seriously the attached responsibilities. Perhaps more interesting from  a legal perspective, and more worrying for corporate groups, is that the court also found that other group companies, and individuals in them, were also liable for the full amount due to their "dishonest assistance" of a breach of fiduciary duty. That potentially gives a claimant a much wider range of defendants to aim at, and could effectively avoid the limited liability of the company. It is not only the deluded nominee director who is at risk, but also those who give him instructions and devise the company's transactions. The other people involved could could not honestly have considered the transactions to be in the company’s interests, in the light of what they knew, so they were liable for dishonest assistance.

Turning a blind eye can be enough to establish liability for dishonest assistance: “Dishonest assistance requires a dishonest state of mind on the part of the person who assists in a breach of trust. Such a state of mind may consist in knowledge that the transaction is one in which he cannot honestly participate (for example, a misappropriation of other people’s money), or it may consist in suspicion combined with a conscious decision not to make inquiries which might result in knowledge..." (Barlow Clowes International Ltd v Eurotrust International Ltd).

No-one should ever act as a "nominee" director, in the sense of blindly acting on the instructions of someone else; but nor should anyone assume that they can safely let such arrangements go ahead when it is plain that there is a breach of duty, or  plain enough to require further investigation.

Insolvency and consumer credit businesses

A trap for administrators and a workload for the FCA

Consumer credit businesses used to be licensed by the OFT, in a fairly relaxed licensing regime. It included not only consumer credit lenders, but also businesses with a tangential involvement in credit such as credit brokers, debt collectors and debt advisers. Credit brokers include most businesses who introduce consumers to credit providers, such as motor, furniture and electrical retailers. Many large businesses held consumer credit licences for minor activities outside of their main businesses, such as employee loan schemes or other employee benefits.

The Financial Conduct Authority has now taken over regulation of consumer credit, with all the complexity of the financial services regime. Consumer credit businesses have become "authorised persons" (including those who have the transitional "interim permission"). That has many consequences, some of them possibly unforeseen. One of them is the application of the FSMA insolvency legislation to all consumer credit businesses.

A possible major trap is that an appointment of an administrator by the directors of a consumer credit authorised business, or of one that should be authorised, needs the prior consent of the FCA (section 362A FSMA 2000). The directors must obtain the consent of the FCA before filing a Notice of Intention to Appoint Administrators, or if there is no qualifying floating charge holder and therefore no need to file such a notice, the consent must be filed at the same time as the Notice of Appointment of Administrators. Failure to obtain the FCA’s consent renders the administrator's appointment invalid; but the case of Peter Lloyd Bootes and others v Ceart Risk Services Ltd holds that this is a curable defect, so the appointment will take effect when the consent is obtained and filed.  

If there is a qualifying floating charge holder, and it makes the appointment, no prior consent of the FCA is required. But all documents in relation to the administration issued to creditors must also be sent to the FCA, and similar requirements apply to other forms of insolvency.

This is yet another thing for insolvency practitioners to look out for before appointment, and a potential source of uncertainty in the validity of appointments. A search of the FCA register should probably be routine (and the separate specialist registers, including the consumer credit register), but even that is not complete protection: if the business should have been authorised, for instance because it introduced consumers to credit providers, the FCA's consent is still needed. Whether the FCA will give timely consents in respect of firms it has never heard of, or precautionary applications for consent, remains to be seen.

Proportionate liability clauses upheld

Need a small slip make you liable for the whole loss?

For many years, businesses have been trying to limit liability according to their fair share of the fault.  Among the first to argue for "proportionate liability" were the big accountants, who are regularly sued over corporate failures because their insurers had deep pockets. The issue frequently arises in the constructions industry, where there are often several firms of contractors and professionals who might share responsibility for a fault or delay.

In most cases, where there are two or more possible defendants, they will be jointly and severally liable for the loss. that means the claimant can sue any or all of them, and recover the whole of his loss from the chosen defendant, leaving the defendants to sort out contributions amongst themselves. that can be very unfair to defendant if the others have gone bust or disappeared. In the very worst cases it can even make claimants careless about the choice of contractors: so long as they have one solid defendant, they need not worry about the competence or financial strength of the others.

"Net contribution clauses" have often been inserted in contracts, but lawyers have doubted whether they worked. Now the Court of Appeal has confirmed that they do - even in consumer contracts.

In West v Ian Finlay & Associates a very simple term was held to work: "Our liability for loss or damage will be limited to the amount that it is reasonable for us to pay in relation to the contractual responsibilities of other consultants, contractors and specialists appointed by you". The clause protected an architect from liability for the part of the claimant's loss fairly attributable to defective work by the (insolvent) building contractor. It survived challenges under the Unfair Terms in Consumer Contracts Regulations and the Unfair Contract Terms Act 1977.

All businesses which could potentially share liability with others should review their contract terms and consider whether they should be using a net contribution clause. That includes most businesses in the construction industry and most professional firms. It remains to be seen whether the same approach can be extended to exclude liability for the defaults of your own sub-contractors.

Retention of title and paying the price

Tangled ROT clauses come unravelled

Retention of title (ROT) clauses have been controversial for over 30 years. When selling goods to a business buyer on credit, you want to keep ownership of your goods until you are paid. If the buyer goes bust, you can hope to retrieve your goods, or claim their value in priority to the unsecured creditors of the buyer. You need an express contract clause to do this: it is not a right given by the general law.

We had thought the law on ROT clauses was becoming fairly settled. The long arguments that used to accompany almost every insolvency are now reduced to a bit of wrangling with the insolvency practitioner. It is fairly settled that the basic form of ROT clause works: you retain title to your goods until they have been paid for. Fancier extensions of the clause are usually not effective. They include:

·         the “all monies” clause which purports to retain title until every debt owed to you has been paid – where there is continuous trading between the parties, this would mean that title would never pass because something was always owing

·         trying to continue ownership of the goods after they have been sold to the buyer’s customers – quite apart from practicalities, section 25 of the Sale of Goods Act says that a buyer in possession of goods with the permission of the seller can pass good title to a buyer from him

·         trust clauses, which purports to give you special rights over the proceeds of sale of the goods when your buyer sells them on. These usually amount to a charge, requiring registration at Companies House and ranking behind other charges on the buyer’s assets

·         agency clauses, which say that the buyer is not in fact buying at all, at least until he pays you, and if he sells the goods you are entitled to the full price from his buyer. If this works at all, this makes you a party to the contract with the sub-buyer and liable if anything goes wrong with the goods. In most cases it is inconsistent with the true commercial relationship and is likely to be ignored.

Two recent cases do not change this position greatly, but they do point to the importance of the drafting of the clause, and also to the fact that a clause which tries to do too much could end up not achieving anything at all. And that the law is still a mess.

Sandhu v Jet Star Retail Limited (in administration) and others is not particularly surprising. An “all monies” clause was held not to work. The surprising aspect was that the ROT clause failed completely, rather than applying just to the price of the actual goods remaining in stock. It is a very short judgment, but the reasoning seems to be that the administrators had already sold the stock before any claim was made, and the terms of the contract expressly allowed the buyer to sell the goods, and did not terminate that right upon insolvency. Therefore, the administrators were entitled to sell the goods, the retention of title ended upon sale and the administrators had done nothing wrong and so were not guilty of the tort of conversion (dealing with goods in a manner inconsistent with the owner’s rights). Had the clause been better drafted, it could have protected the seller so that he received at least the value of the goods remaining in stock at the time of insolvency, or the contract price for those goods, whichever was the lower. It is usually better to be conservative and draft your clause in a way that is likely to be effective under the current understanding of the law, rather than attempting to gain additional rights which put the whole clause at risk.

The more difficult case is Caterpillar (NI) Ltd v John Holt & Company (Liverpool) Ltd, a Court of Appeal case which I hope will be reviewed by the Supreme Court. This case again revolved around sub-sale of the goods by the buyer. The ROT clause was an “agency clause”, which purported to say that the first buyer received the goods not as a buyer, but as the agent of the seller, and sold them to the second buyer as agent of the seller. The Court of Appeal accepted, surprisingly, that this worked, and held that it meant that the first buyer was not liable to pay the sale price to the seller, as it had not bought the goods! Section 49 of the Sale of Goods Act says that a seller can sue for the price either when title to the goods has passed to the buyer, or  “the price is payable on a day certain irrespective of delivery”. As neither of these conditions applied, the seller could not sue for the price. He could probably claim damages for breach of contract, but that was outside the scope of the decision.

If this case remains good law, there are a number of steps sellers can take to improve their ROT clauses and payment clauses, including ensuring that payment is due on a “day certain irrespective of delivery” and removing any reference to agency. Clauses should either not expressly authorise resale of the goods at all, or if they do, should make sure this right does not continue following default and insolvency.

Directors: personal duty or collective responsibility?

Can a director rely on fellow directors or on majority decisions?

This post is devoted to a quotation from a judgment of Mr Justice Popplewell explaining the degree of personal responsibility of directors for collective decisions, and how far a director can rely on his fellow directors:

"It is legitimate, and often necessary, for there to be division and delegation of responsibility for particular aspects of the management of a company. Nevertheless each individual director owes inescapable personal responsibilities. He owes duties to the company to inform himself of the company's affairs and join with his fellow directors in supervising them. It is therefore a breach of duty for a director to allow himself to be dominated, bamboozled or manipulated by a dominant fellow director where such involves a total abrogation of this responsibility ... In fulfilling this personal fiduciary responsibility, a director is entitled to rely upon the judgement, information and advice of a fellow director whose integrity skill and competence he has no reason to suspect ... Moreover, corporate management often requires the exercise of judgement on which opinions may legitimately differ, and requires some give and take. A board of directors may reach a decision as to the commercial wisdom of a particular transaction by a majority. A minority director is not thereby in breach of his duty, or obliged to resign and to refuse to be party to the implementation of the decision. Part of his duty as a director acting in the interests of the company is to listen to the views of his fellow directors and to take account of them. He may legitimately defer to those views where he is persuaded that his fellow directors' views are advanced in what they perceive to be the best interests of the company, even if he is not himself persuaded. A director is not in breach of his core duty to act in what he considers in good faith to be the interests of a company merely because if left to himself he would do things differently."

I don't think I can usefully add to that.

The quotation is from the (rather lengthy) judgment in Madoff Securities International Ltd v Raven & ors in which the liquidators of Bernard Madoff's UK company attempted, wholly unsuccessfully, to claim against the directors (other than fraudster Bernard Madoff himself) for breach of duty. Among other things, the court affirmed the principle that shareholder approval cures most breaches of duty in an apparently solvent company.

I am indebted to Robert Goddard's excellent Corporate Law and Governance blog for identifying this excerpt and editing it.

Vendor funding of business sales

a substitute for bank borrowing?

The market for company sales is slowly picking up after five long years of slow activity. A measure of confidence is back as the Euro crisis fades from the headlines. There is pent-up demand from sellers and buyers. Investors with cash are looking for a return, and equity markets are booming when other investments look unattractive. Companies are looking for a strategy that takes them beyond the defensive mindset of recession.
 

The major obstacle to mergers and acquisition activity remains the lack of funding from the banks. There is no likelihood of that changing, so parties to deals are looking for other ways to finance deals. Top of the list is vendor funding, by deferring payment of the price.
 

Vendor funding can be attractive. It allows deals to be done with little or no dependence on outside parties, and it may allow the seller to maximise the price through an earn-out arrangement, so that the price depends on the results achieved by the new owners. It can have tax attractions, by allowing the seller to spread his gain over several years.
 

Deferred deals do have some serious drawbacks, which are often not appreciated by the parties at the outset. They include:
 

• The seller can end up paying himself out of his own money. He gives away the upside (future growth) but retains all the risk. If the only source of payment is the earnings of the company, why sell? Why not keep the company and the earnings? 

• Credit risk: the deferred price is often unsecured, so that it will not get paid if either the buyer or the company goes bust. Sellers often ask for security, but often there is none of any value to be had: any assets in the company are likely to be charged to the bank, and any seller debt is likely to be postponed to the bank to the point of making the second charge almost valueless. On the other hand, if the company charges its assets to the seller it may find itself unable to borrow. There may be big, expensive arguments between the seller and the bank about priority of security and whether the seller is allowed o enforce his security.
• Sellers sometimes try to get the company or business back if the buyer does not pay, but that rarely works either. By the time the buyer defaults, the company is usually in a worthless state, and the right to recover it might well be unenforceable if an insolvency is involved.

• Buyers usually will not give personal guarantees. If they are not risking enough of their own money, they may have little incentive to make the business succeed and pay out the seller, especially if things star falling behind plan. The seller may find he gets his business back by default.

• The seller may be pressurised into renegotiating of the deal partway through, if there is a risk that he will not recover the full amount he is owed.

• Tax structuring is delicate: the seller does not want to pay tax on money he may not receive, but also wants to protect his entrepreneur’s relief.

• A variable price increases the risk of the deal to both parties. Each will be suspicious of the other’s involvement in the business as they try to manage conflicting priorities. Sellers will want some control to protect what is owed to them, and to keep the business largely unchanged so that its performance can be measured; buyers will want freedom to manage the business, including making major changes such as selling or merging.

 

With the risk increased all round, expert legal advice is essential. I have been handling corporate deals for 30 years with a specialisation in earn-outs and deferred deals. I know the practical realities as well as the legal theory. Call me to discuss your project.

 

The Game is the winner

HMRC takes another kicking over football creditors

Many of my readers will know that I was deeply involved in the rescue of Wimbledon Football Club from administration, as it went on to become the mighty MK Dons.  I was there, in the Court of Appeal, when HMRC’s challenge to the CVA, and indirectly of the Football League’s football creditor rule, took a 3-0 drubbing. [1] Leading Treasury Counsel had his legs taken out from under him by the Lord Chief Justice in the first five minutes.

So I was a bit surprised that HMRC has had another go, this time in proceedings against the Football League itself. HMRC was knocked out in the first round by Mr Justice David Richards. [2]

The football creditors rule has been deeply unpopular with HMRC and other non-football creditors for many years, because it requires football creditors (players, managers, other clubs and the League itself) to be paid in priority when clubs go into administration, leaving less (or nothing) for the unsecured creditors. It offends against the usual principle that unsecured creditors rank equally and get paid proportionately. It works by not allowing the club to play in the League unless the football creditors have been paid. So any buyer will pay off the football creditors and knock the cost off what he would otherwise have paid for the club. Because the money does not go through the administrator’s hands, he cannot distribute it equally. To add insult to injury, the creditors are then asked to agree a CVA (company voluntary arrangement) that prevents them from pursuing their claims; if they don’t agree, the club goes into liquidation and they get nothing.

HMRC tried to use the anti-deprivation rule, which invalidates arrangements that deprive a debtor of assets on bankruptcy. The court held that this can apply to an administration, but its scope is narrow and the funds in question in this case are not assets of the club at the time of administration.

It remains to be seen whether HMRC seeks a return match in the Court of Appeal, but there is not much in the judgment of David Richards J. [3] to give them any hope.

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[1] Inland Revenue v Wimbledon Football Club Ltd & Ors Rev 2 [2004] EWCA Civ 655

[2] I’m getting old. I remember instructing David Richards as (very) junior counsel.

[3] HMRC v The Football League Ltd & Anor [2012] EWHC 1372 (Ch)

Time for a sharp Grexit?

Business implications of Greece leaving the Euro

At last our politicians are admitting the possibility of a Greek exit, and the need to plan for it. But what are the implications for businesses trading with Greece, or with assets there? Here’s one lawyer’s view.

A Greek exit would take one of two forms: a unilateral decision by Greece, or a managed process agreed by the whole EU, or at least the Eurozone. An exit means breaches of the EU treaties, so we are talking about political decisions rather than legal mechanisms. Anything done without formal agreement by all EU member states would be illegal, but that doesn’t mean it can’t and won’t happen – international law doesn’t work like that. Once a Greek exit has been announced, all involved will be under enormous pressure to reach agreements to mitigate the damage, so a unilateral exit could turn into a managed process, perhaps ending with a retrospective treaty. Although a Greek default and exit would be greeted with initial hostility, governments may actually help the Greek government in order to preserve stability in the rest of the Eurozone. Businesses and individuals in other parts of Europe cannot assume that they will be protected by their own legal systems.

Cash

All Euro notes and coins circulating in Greece would (theoretically) be converted into new Drachma at an official exchange rate, making them far less valuable than other Euros. It’s unlikely that the distinction would be made by the country-specific designs of the Euro coins, or the “Y” prefix of the serial number on Euro notes. Notes within Greece would probably be overprinted with a Drachma designation, and banks would close until they could start issuing the Drachma notes. Of course it will be in Greek citizens’ interests to avoid the overprinting and to take their Euro notes abroad, and we can expect border controls and massive currency smuggling. Eurozone governments may want to co-operate in stemming this, as contraband Euros will undermine good German ones, so European governments could introduce bans on possessing or exchanging Euros known to have been smuggled from Greece, and could seize the currency – though not once it was circulating in their own countries.

Bank Deposits

All Euro deposits in Greek banks in Greece will be converted into devalued Drachma, assuming that the banks themselves survive. Even foreign depositors are unlikely to have any legal remedy. Local deposits in foreign banks are likely to be governed by Greek law. Deposits in foreign branches of Greek banks in Euros are probably repayable in Euros. Greek depositors will be rushing to get their deposits abroad, and ideally outside the Eurozone, or to invest them in other currencies such as dollars or sterling. It is possible that the EU, or the Eurozone, would attempt to help Greece by converting Euro deposits in European banks held by Greek citizens or residents into Drachma; that would be controversial and administratively very difficult, especially for small consumer deposits. Greek law may compel its citizens to repatriate their assets, though Greeks may not hurry to comply.

Debts and payment obligations

The whole network of business relationships would be thrown into chaos, with losses falling almost randomly on someone in the supply chain. Euro-designated debts in Greece covered by Greek law would be redenominated into Drachma and could be settled in devalued Drachma. It is likely that Greek citizens or residents would be protected by Greek law against being sued for Euro debts, so even if your contract is governed by English law, you are likely to have difficulty enforcing a Euro judgment in Greece. If the debtor has assets outside Greece, you may be on stronger ground.

All international contracts should include a choice of law and jurisdiction. If you supplied a customer in Greece for a price in Euros under an English law contract, how will you fare? UK jurisdiction is specified, and the court will allow the claim to be served outside the UK – though you might be in difficulty if the customer was a consumer. English courts can give judgments in foreign currency, but will they award Euros or Drachma?

Lex monetae says that where a contract refers to a currency, there is an implied choice of that country’s law to decide what constitutes the currency and payment. It is unlikely that this would apply if Greece seceded and the Euro continued, but it could apply if the Euro broke up, or more likely if the whole Eurozone passed legislation saying which debts were redenominated. That could itself be controversial, as non-Eurozone member states (such as the UK) might block EU legislation that prejudiced UK creditors; the European Court would probably contort itself to protect the Eurozone.

Otherwise, payment obligations will be governed by the chosen law of the contract. English law is likely to say that a Euro obligation must be paid in Euros. The English court’s judgment could then be enforced against the debtor’s assets in the rest of Europe (other than Greece) or (with more difficulty) in many other places

You may need to take care not to acquiesce in the conversion of your debt into Drachma, for instance by accepting the Drachma payment and then attempting to claim the rest of the Euro amount. The actual terms of your contact may be important – if it defines “Euro” as the currency of Greece, you may be in trouble. Any place specified for payment may also be important. If making contracts now, be specific about these things.

Other contractual obligations

Failure to pay in the contractual currency on time will often be an event of default, which may entitle the other party to bring the contract to an end and claim damages – though notice may be needed if time is not “of the essence.”

The imposition of exchange controls could make some contracts legally impossible to perform, in which case they could be frustrated – in which case neither party has a claim against the other, and any loss lies where it falls. Grexit could also trigger “material adverse change” or “force majeure” clauses in some contracts. Otherwise, the contract is likely to continue (in the absence of an insolvency) with the consequences being decided by the courts. If you are about to ship goods, uncertain as to whether you will be paid in Euros or Drachma, you have a difficult decision to make: don’t ship, and risk being sued; or ship the goods, and risk not being paid.

Breaches of exchange control may be criminal offences, in Greece or in other EU states. If it became illegal under English law, or possibly under other laws, to perform your contract, you will not be obliged to carry on. There may be other legal changes in Greece or elsewhere, which could be quite oppressive, such as restrictions on the movement of assets or people. Foreign governments could pass legislation imposing sanctions on Greece, or attempting to protect their citizens and companies from the worst effects of Greek default. They might enforce mutuality, saying that if Greece is only paying its debts in Drachma, debts owed to Greek parties may also be settled in Drachma.

Guarantees and securities for Greek Euro debts have to be interpreted according to the relevant law, but are likely to follow the main payment obligation: so an English law guarantee of a Greek Euro debt would usually guarantee whatever the payment obligation was under the main contract. Contracts or mortgages relating to land in Greece are likely to be governed by Greek law.

Insolvency and State immunity

Many Greek commercial companies are likely to go bust. Europe-wide recognition of insolvency proceedings probably means that their UK assets will be protected from seizure, so that they are distributed to creditors in an orderly fashion. There is no insolvency law for nations, so enforcing government debts and seizing assets will be a free-for-all. UK creditors may have a head start, as many Greek government and bank financial assets are likely to be located in London.

Foreign governments are protected against being sued, but sovereign immunity does not apply to commercial transactions, including State borrowing.[1] When Argentina defaulted on its sovereign debt, there were many examples of bondholders successfully suing in foreign courts and enforcing against foreign assets. Sovereign immunity would protect the Greek government from claims for damages, for instance to recover losses flowing from its breach of the EU treaties.

What if I’m the debtor?

If you owe money in Euros, you may want to try paying in Drachma. If your contract is closely connected with Greece, you may get away with it. The arguments above apply in reverse, but Greek law may make it more difficult for Greek companies to claim settlement of their bills in unreconstructed Euros.

What should I do now?

Many people will be pulling money and assets out of Greece. If trading there, get paid in advance. Remember that any letter of credit or performance bond may only be as good as the underlying obligation, when it comes to currency. If you have a gambler’s mentality and still want to extend credit to Greek parties, make sure your contract is under English law and jurisdiction. If you must make Euros the payment currency, make it clear that you are talking about the European currency and not the Greek one – or perhaps specify the currency of Germany! Include an indemnity by the other party requiring them to compensate you against any loss flowing from their country leaving the Euro, including exchange losses and payment delays. Review what would happen if the other party, or his associates and subcontractors, disappeared in a maelstrom of insolvency and cross-default following Grexit. Make a redesignation of the currency an event of default. And while you’re changing your terms of business, what about Portugal, Ireland, Spain, Italy?

If you’re a bank, launch an advertising campaign in Athens – seeking deposits in nice, safe sterling in an account in London.

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[1] State Immunity Act 1978