Lawyers, justice and legal funding

Why litigants need lawyers

I didn't write this but I thought it was well put, explaining the impact of populist anti-lawyer attacks, the effect of cutting public funding for the public and why the courts are jammed up: 

"Back in the day, he'd have got free legal advice and that legal advice would have been by respected professionals able to explain to him that his case was not going to win. Now, litigants are told all lawyers are lying scheming toads, and that you don't need them and you can win your case just by virtue of being "right". Of course show me a litigant who doesn't think they're in the right and should win, and I'll show you a flying pig! So people with hopeless cases pursue them and then (unsurprisingly) lose. But what's the reason for losing? It can't be that they didn't have a case. It must be that the judge is corrupt." (Dominic Cooper, comment on Law Society Gazette website)

I would add that the unrepresented and unadvised litigants often don't understand finality in the courts. If they lose a case, perhaps because of procedural mistakes (such as not providing their evidence) they feel that "justice" requires that they should be allowed another go. Resulting in further anger and frustration, like the chap who called the police from the courtroom and asked them to arrest the High Court judge for treason!

Lawyers have an important role in the justice system. They know what courts are likely to decide, so their advice stops bad cases coming to trial - the vast majority of civil claims are settled. Lawyers understand procedure, so they can gather the necessary evidence and present the client's best case on the day. In criminal cases, they ensure that defendants make informed choices (such as guilty pleas) and are given a fair trial with proper testing of the evidence. Without lawyers, the courts are landed with the impossible task of dealing with chaotic cases, raw unreviewed evidence and bewildered parties. Judges are not investigators. They can only deal with the evidence presented to them.

Practising law is about predicting what courts will decide. A party with no case and no evidence - perhaps a defeated US president - cannot stave off the inevitable by insisting on his day in court, as if the outcome is some random event. Equally, the rights and wrongs of a genuine dispute cannot be decided by one party (often the government) denying the other the right to have the facts established on the evidence.

Legal assistance has to be paid for. Public funding for legal advice is not, as Daily Mail headlines constantly scream, to provide a benefit to criminals or illegal immigrants - it doesn't go to them. It is to make the justice system work, to find out whether there is a genuine dispute, to keep bad cases and bad arguments for overwhelming the courts, and prevent mistakes by the State destroying lives unchallenged.

Populist attacks on lawyers for doing their jobs - allowing people to assert the rights given them by Parliament and keeping the justice system running - are iniquitous attacks on the rule of law.

Solicitors' ethics: the client or the public?

How should lawyers deal with disreputable instructions?

The Solicitors Regulation Authority has published another warning about solicitors becoming involved in dubious investment schemes, after recent cases led to the closure of seven firms and other regulatory action. This rightly highlights the welcome change of attitude we solicitors have had to make. 

It used to be that we represented the client's interests without regard to any wider morality, so long as we were not knowingly participating in criminal conduct or misleading the court. Now, we are required to have broader ethical standards and to have a duty to the public. I'm glad about that. 

Lawyers are now expected to carry out some due diligence and assure themselves that their clients are behaving legally, rather than just accepting the assurances and half-truths clients my give them. The public may assume, rightly or wrongly, that because a solicitor is involved, the investment is legitimate or money is protected.

Professional ethics grew up in the admirable tradition that solicitors represent their clients fearlessly and independently, and that everyone is entitled to legal advice. Solicitors rightly represent people accused of crimes or wrongdoing without allowing personal feelings to cloud judgement, drawing the line at actual knowledge: if you don't know your client is guilty, you can and should represent him in court. But in transactional matters we need a more rigorous approach that avoids actually assisting in schemes that are suspicious or disreputable. The fearless and independent advice is then that the client should not do it. 

UK company fined at home for failing to prevent bribery overseas

A bung can cost more than a fistful of dollars

Last week Sweett Group PLC became the first company to be sentenced for the crime of failing to prevent bribery by an associated person (s7 Bribery Act 2010). One of its overseas subsidiaries paid bribes to secure a contract concerning an hotel in Abu Dhabi: Sweett Group is an AIM-listed construction consultant.

An English court imposed a fine of £1.4 million and a confiscation order of £851,000, plus costs. A number of lessons can be learned:

·     The Bribery Act has not gone away: the noise made by law firms when it came in has abated, but the Serious Fraud Office will prosecute British companies for failing to stop corruption overseas

·     Co-operating with the authorities will not always avoid prosecution – Sweett Group reported itself after it got media attention, but the SFO did not even offer a “plea bargain” deferred prosecution agreement

·     Penalties can be swingeing

·     Professional practices are not immune

·     UK companies must take precautions: demonstrable adequate procedures to avoid bribery, and an anti-bribery culture must exist before the problem arises.

Penalty clauses are unenforceable - aren't they?

It was never a penalty!

The law has been clear: a clause in a contract imposing a penalty for breach of contract was unenforceable. What was completely unclear was  (1) what amounted to penalty and (2) whether the rule applied beyond the payment of money following a breach of contract. For many years the accepted formulation was that if contract term provided for a payment which was "more than a genuine pre-estimate of loss" it would be an unenforceable penalty; otherwise it was a legitimate "liquidated damages" clause and not a penalty. In more recent years more complex cases have tested the rule, involving more than a straightforward payment for non-performance. the trend seemed to suggest that any clause whose effect was intended to be deterrence rather than compensation was potentially vulnerable to attack as a penalty.

In a judgment today (4 November 2015) these developments of the law on invalid penalty clauses has been rolled back by the Supreme Court. It gave a combined judgment on two cases that could hardly be more different. Cavendish Square Holding v El Makdessi concerned "bad leaver" type clauses  under which Mr El Makdessi, who had sold shares in a company, stood to lose the remaining instalments of the price and to be forced to sell his remaining shares cheap — the last limb alone would cost him $44m — because he had breached non-compete covenants. ParkingEye v Beavis was about an £85 penalty charge for overstaying in a retail car park.

In both cases the Supreme Court said the clauses were not penalties and were valid. The test for a penalty is now "whether the sum or remedy stipulated as a consequence of a breach of contract is exorbitant or unconscionable when regard is had to the innocent party’s interest in the performance of the contract", which will allow far more aggressive terms than some of the cases suggested. Deterrents are allowed, so long as they are not exorbitant or unconscionable, and there is no longer any necessary relationship with the damages that might be awarded by the courts for the breach. Contract writers are likely to become bolder in specifying remedies for breach.

Most “bad leaver” clauses are now probably safe, though still subject to possible equitable relief from forfeiture if the party in breach can provide recompense by other means. 

The £85 parking overstay charge was also held not to be an unreasonable term under the Unfair Terms in Consumer Contracts Regulations 1999 (now Part 2 of the Consumer Rights Act 2015).

The Supreme Court did close one loophole: in deciding whether the clause is a remedy for a breach of contract, the courts will look at the substance of the obligations and not just at how they are expressed. Writing the contract so that there is no breach, but just a conditional obligation, will not get round the rule on penalties if the substance is that one is the primary obligation and the payment is a secondary compensation: so if instead of saying "you must supply the goods; if you do not supply the goods you will pay me £1m" you say "you can either supply the goods or pay me £1m", the court can still decide that the supply of the goods is the primary obligation and the payment is a penalty for breach of it.

The case is a victory for traditional freedom of contract and for certainty, at the expense of the introduction of concepts of fairness, proportionality and the protection of the weaker party into contract law.

US stock option plans subject to English law?

Courts clash on jurisdiction over employees 

It will come as a great surprise to many international employers that their US stock option plans are subject to the exclusive jurisdiction of European courts, as the plans apply to employees in Europe.

Many American companies offer stock option plans or other share incentives on a global basis, with employees having conditional rights to receive stock in the US holding company, or stock issued by a vehicle created for the purpose in the USA. The stock option plan will be established in a state of the USA and subject to its laws, and may or may not be tailored through sub-plans to meet tax requirements in other countries, such as the Enterprise Management Incentive Scheme in the UK.
Rights are granted under a contract direct between the American entity and the employee. 

The Brussels Regulation (recast) governs the jurisdiction of all courts in the EU to hear cases, and says that an employer may bring proceedings only in the courts of the Member State in which the employee is domiciled. At first glance, the stock plan is not an "individual contract of employment" and the US entity is not the employer, so the special rules for contracts of employment in would not apply. As an English lawyer I have no difficulty with the concept of a separate contract with a third party dealing with stock options or incentives, and I would not consider it to be a contract of employment, or the incentive provider to be an employer. Indeed, in English law it has been held that a share option is not a term of the contract of employment: Micklefield v SAC Technology Ltd [1990] 1 W.L.R. 1002. 

But Samengo-Turner v J & H Marsh & McLennan (Services) Ltd held that words used in EU legislation must be given an autonomous (European) meaning so that each Member State will apply it consistently and not interpret it in accordance with its own national law. The terms of the Brussels Regulation are essentially an employment protection measure, to stop employees being sued anywhere other than than their own home jurisdiction, and the English courts would give effect to that: not only by including any contract relating to employment as an "individual contract of employment" and the benefits provider as an employer, but also by granting an anti-suit injunction preventing the foreign company from taking proceedings in its own country.

In the recent case Petter v EMC Europe Ltd the English Court of Appeal became engaged in an unseemly scramble to establish jurisdiction either in England or in Massachusetts, with both courts being asked to grant injunctions preventing a party from continuing proceedings in the other place. Courts of different countries usually try to respect each other and not fight over jurisdiction, but in this case the Court of Appeal decided it had to grant an injunction effectively overturning the decision of the Massachusetts court, in order to protect the employment rights of UK employees.

A fight over the choice of court is not the end of the matter: an English court will still apply foreign law if that is the law chosen in the contract: the Rome I Regulation on the law applicable to contractual obligations allows the parties to choose the applicable law, even for a contract of employment, and an English court can apply foreign law if presented with evidence of what the foreign law is. However, this is subject to the application of mandatory rules of local law. Whilst the courts of England and Massachusetts should theoretically apply the same laws in reaching their decision, a court in England is likely to give far greater weight to English employment rules such as the duty of trust and confidence between employer and employee, principles of English law banning contractual penalties and granting relief from forfeiture of assets, restrictions on deductions from pay and the requirements for non-compete restrictions not to be unreasonable restrains of trade. The legal environment in the UK is far more friendly to the employee than in the USA, so employees may be very keen indeed to have any litigation heard here.

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.

New Companies House search facility

First impression of the new free access to UK company data

The new Companies House search facility, giving free access to information on UK companies and copies of filed documents, has been launched in beta here.

My first impression is that it's excellent - immediate one-click access to documents, a huge improvement on the previous elaborate process of selecting, paying for and downloading documents through the public Webcheck facility and the subscription services used by business customers.

The only downside I can see is that information is now so easily accessible that I'm sure there will be an increase in abuse. There appears to be no attempt to prevent automated services harvesting information, which is now all free of charge, which could be used to assist in identity fraud, to identify targets for spam, or to put together more sophisticated abuses. the information was all there before, but was only available if you knew you wanted it and  were prepared to pay your quid per document.

Unsigned contracts can be binding

Not worth the paper it isn't written on?

A recent High Court case is the latest reminder that even where the parties intend to enter into a formal written contract, they can become bound by the contract even before it is signed.

Most kinds of contract do not need any particular formality, such as written terms or a signature (property contracts being a notable exception). Written terms can be accepted orally. Contract terms can be accepted by conduct, even where the written terms make it clear that a formal signature was expected, and even where there are remaining terms that have not been agreed.
In A v B the buyer of a large quantity of cotton did not sign the purchase contracts, but did initiate the price fixing mechanism under the contract terms. The court held that this was unequivocal acceptance of the contract terms, so the buyer was bound by the contract. The seller was awarded over US$7m.

This is not new: if the parties work under the terms of a document, even a draft document, the court is likely to conclude that they intended those terms to be binding. Similar cases include RTS Flexible Systems Ltd v Molkerei Alois Muller Gmbh & Company KG (UK Production) in the Supreme Court in 2010, and it was held long ago that the partnership deed for a solicitors' firm became binding even though it was never formally executed.

Once commercial parties start to work together, the court will be very reluctant to find that there is no contractual relationship. The question then is what the agreed terms are. the most obvious source is the latest draft of the proposed written contract. that seems obvious, if all the terms were in fact agreed; but what if one party was holding out for something they regarded as important, which the other side clearly had not agreed? In RTS v Muller the Supreme Court said "an objective appraisal of their words and conduct may lead to the conclusion that they did not intend agreement of such terms to be a pre-condition to a concluded and legally binding agreement." So it is bad luck, or carelessness, on the part of the person arguing for the extra condition.


The same applies to an agreement that is expressly "subject to contract". If the parties start to work to the terms, the court is likely to say that the "subject to contract" position has been waived.

There would be no contract if all the "essential" terms were not agreed, but what is "essential" is just the legal minimum to create a binding contract. The law does not require all commercially-sensible terms to have been agreed - just price and quantity may be enough.

These cases are over the negotiation of bespoke terms, but they are related to the "battles of the forms" where both sides try to impose their standard terms - usually the buyer is assumed to have accepted the seller's terms by accepting delivery of the goods.

How should you protect yourself? If you must start work on a project before the formal contract is signed, it is best to have an interim agreement (often called a letter of intent) that sets out the terms for the immediate work, and what will happen if the parties fail to reach agreement on the main contract. An agreement to agree is generally unenforceable, so the interim agreement should include terms to unwind the relationship and ensure that no-one loses out unfairly if the terms do not get agreed.

What does "in witness" mean in in my legal document?

What meaneth witnesseth?

What do those strange words about "witnesseth" (or similar) mean, at the beginning and end of a legal document?

Apart from telling you that your solicitor is a bit old-fashioned, they don't add a great deal.

"In witness whereof" does not have anything to do with witnesses to the signatures. It means "as evidence of which", or "to demonstrate their agreement". It has no particular legal significance in the modern age, except that in England a document intended to have effect as a deed must say so, and this is the usual place to do that: "in witness whereof the parties have executed this document as a deed on..." This is the "testimonial clause"  or "incujus rei testimonium" and it matches the testatum at the beginning of the document, after the recitals, traditionally "Now this deed witnesseth...". What is sandwiched between the two is the operative part of the deed, so the recitals or schedules do not normally have legal effect as operative provisions unless the deed says so.

It can certainly but put in modern English. I start the business part of my documents with a heading "Operative provisions:" and end with "The parties have [signed this agreement][executed this document as a deed] on the date stated at the top of page 1." I just hope my abandoning tradition never ends up being challenged in the Court of Appeal!

Address for service

Directors' risk of being served with a claim in the UK

Directors of UK companies have to give an "address for service" to Companies House. This came in in 2009 as a trade-off for the ability to conceal the director's home address (section 1140 Companies Act 2006).

In a surprising decision, a Master of the High Court has ruled that the address for service at Companies House can be used to serve any document on the director, including a claim form starting legal proceedings against him which were unrelated to the company in question (Key Homes Bradford Ltd & Ors v Patel [2014] EWHC B1 (Ch) 10 January 2014). That applies even if the director is not in the UK, and proceedings against him could not otherwise be started in England without the court giving leave to serve proceedings outside the UK (which is not automatic), and an expensive process of serving abroad. The usual rules of court requiring an individual to be served at his usual or last known residence are overridden.

Directors' addresses for service are often given quite casually, often as the company's registered office, perhaps without consulting the director in question. Now it is clear that directors should take more interest, especially directors resident abroad. Giving an address for service in the UK makes them vulnerable to being sued in England much more easily, even in unrelated matters. They can also be seriously prejudiced if proceedings are served at the company's offices and are not passed on. Disputes with the company are a particular risk: the company may be tempted to serve its claim at its own office, not pass the papers to the defendant, and enter judgment in default.

It is even possible that the address for service can be used for things that would otherwise have to be served personally, such as a statutory demand in bankruptcy or a court order threatening imprisonment for contempt.

Advisers should be much more careful in future about giving an address for service for directors, especially for those resident overseas. The address given does not have to be in the UK, and if it is outside the UK it would still be necessary to get leave from the court to serve a claim form there. Even UK directors might want to give an address abroad!

Negligence: staying out of the firing line

Shared responsibility in a professional team

Professionals work in teams, formally or informally, on all sorts of projects. Where something goes wrong, it may not be clear that one professional firm is solely responsible.  One professional may have relied entirely on another to do his bit, either by agreement between them or because it naturally fitted in the other's area of expertise; or one may have appointed the other to assist. Successive advisers may have made the same mistake. Two advisers may assume that each other are dealing with an issue. If work or advice has been negligent, the client will be tempted to sue all parties and let them fight it out amongst themselves. It may come down to assessing the contributions to be made by different parties.

In Flanagan v Greenbanks Ltd (t/a Lazenby Insulation) & Cross two successive firms carried out negligent surveys to assess suitability for cavity wall insulation. The Court of Appeal said that both were liable: the negligence of the later survey had not absolved the earlier one of responsibility, nor could the second firm assume that the first had done its work correctly without checking.

Firms can improve their position if sued by including suitable terms in their conditions of engagement - subject always to the usual considerations on limitation and exclusion clauses, especially in consumer contracts. Something like this can help:

"Where other professionals are engaged by you or on your behalf (including any predecessor of ours), we will be entitled to rely on the work and advice of those other professionals and to assume that they have carried out their work with due care and skill and to all relevant standards. We will not be responsible for checking or re-doing their work, or for checking their instructions, assumptions or conclusions, unless specifically instructed to do so, and then only to the extent falling within our area of expertise. We may review or comment upon the work of other professionals where we consider it appropriate but we will not be obliged to so and by doing so we do not assume responsibility for such work. Where we engage or recommend other professionals, our responsibility for their work is limited to selecting professionals whom we believe to be reasonably suitable for the purpose. Where we engage such professionals with ourselves as principals (and not as your agents) our liability for loss or damage arising directly or indirectly from their act or default (including negligence) is limited to the amount we are actually able to recover from them. If we recommend the engagement of other professionals but you decline to do so, we will not be liable for any loss or damage which would have been avoided had such professionals been engaged."

Of course it also helps if the roles of the professional teams are clearly defined, and if each member has a proper definition of its scope of work and terms of engagement. Specifically exclude from your scope of work any high-risk areas you don't regard as part of your role, and adapt your contract terms carefully to each situation.

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.

Do I need a shareholders’ agreement?

Myths and rumours and minority protection

Whenever a private company has two or more independent shareholders, they will often be told that they should have a shareholders’ agreement. In the broadest sense that’s true: the relationship between the shareholders should always be agreed in some form. But a formal written agreement, in addition to the company’s articles, is not always needed.

The default position is majority rule. A majority of the directors and a majority of the shareholders can do almost anything, especially if they hold 75% of the voting shares. The exception is that they can’t force a shareholder to transfer his shares, except in very limited circumstances. A minority shareholder who does not like the way the company is run has very little comeback. Unless there is misconduct involved, his only hope is the “unfair prejudice” remedy, which is notoriously difficult and expensive to enforce. At best, it gets your shares bought out at a fair market value; it does not stop the unfair conduct, nor is it much good if your shares are worth very little but have excellent prospects for growth.

From the perspective of a majority shareholder, there’s not much wrong with democracy. The one key thing all shareholders should want is the ability to buy back the shares of a shareholder who stops being involved in the business, whether because he leaves, dies or gets pushed out. That is usually put in the company’s articles, and obliges a departing shareholder to offer his shares for sale at a fair price, either to the other shareholders or to the company itself. The exact means of valuation is up for discussion, but more often than not it is a straight proportion of the value of the company, without discount for the fact that it’s a minority shareholding, or the fact that there is no prospect of a sale. The majority probably also wants drag-along rights, forcing a minority to join in any sale of the company approved by the majority.

If those two things are in the articles, and the directors have good, strong employment contracts, the majority shareholder probably doesn’t want a shareholders’ agreement: it will only take away rights he has through his majority control.

A minority shareholder, on the other hand, has lots to gain. A shareholders’ agreement will typically give the minority shareholder a veto over a long list of actions, as well as rights to participate in management and to be consulted. It may give him a right to be a director, or to appoint one, and entrench his position so he cannot be sacked. It may impose obligations on the majority to act fairly, and to commit to a particular business plan. The agreement or the articles will give the minority tag-along rights, giving them the right to be offered the same terms as the majority if the company is sold. The majority shareholder may even be obliged to provide funding, or restricted from withdrawing funding he has provided.

What if there are equal shareholdings, or there is no overall control? In my view there is considerable danger in giving minority shareholders a veto, especially over routine business decisions. The company can become deadlocked and the business grinds to a halt, which is in no one’s interests. I generally say that democracy should rule, and the minority should take their chances. What’s sauce for the goose is sauce for the gander: any shareholder could find himself on either side of the argument, and it’s best if the company is allowed to continue to function and make profits while the shareholders argue. How far take this approach depends on the circumstances and the shareholdings: three equal partners putting a lot of money into a joint venture might want more protection than 20 5% shareholders who are passive investors.

What else would you find in a shareholders’ agreement? Restrictive covenants may be important, restricting the ability of a shareholder to compete with the business after he leaves. For a director, those can be in an employment contract, although restrictions relating to a shareholding are less likely to be struck down as unreasonable.

There is often a dispute resolution process. We often see “Texas shootout” or “Russian Roulette” clauses requiring a shareholder to state a price per share at which he will either buy or sell. They rarely work in practice and I advise against them, unless the parties have equal bargaining power, equal ability to run the company and the financial resources to buy out the other shareholders at short notice. There may even be “bad leaver” clauses, obliging shareholders to sell their shares cheap if they do not perform their obligations in the venture.

Do you need a shareholders’ agreement? It’s foolhardy to go into a jointly owned company without thinking through the issues, but I sometimes conclude that a formal written agreement is an unnecessary expense. The company needs appropriate articles with transfer restrictions, obligations to sell shares on leaving the company, and possibly “drag and tag”. Directors should have employment contracts with appropriate restrictive covenants. After that, if you have two or three equal shareholders, or a large majority against small minority holders, I might well dispense with a shareholders’ agreement and let the majority rule.

On the other hand, where an investor is putting in a significant sum of money, or the minority shareholdings are large, an agreement can be essential to protect the value of their investment. Not all shareholders’ agreements are the same, but the wrong approach can lead either to shareholders walking away with much of the value from the business, or the business grinding to a halt under the dead hand management of shareholder vetoes.

I have been drafting shareholders’ agreements for 30 years; if I can help with yours, do give me a call.

Consumer credit gets the financial services treatment

The FCA takes over licensing in a whole new style

Any business providing credit to consumers, or introducing sources of credit, needs a consumer credit licence. The requirements and standards have increased gradually since licensing came in back in the 70’s. Back then, almost all applications were granted and hardly any licences were revoked. The OFT has never put much resource into the system and has taken a light-touch approach. That will all change when regulation moves to the financial services regulator, the FCA, in April 2014.[1]

The FCA is a far more demanding regulator. It is used to dealing with large institutions with full-time compliance officers, and the resources to apply detailed, complicated rules. The FCA has the resources to deal effectively with complaints and to make life miserable for those it suspects of transgressions, and it is not known for sympathy with small businesses struggling to comply. Apart from the largest consumer credit businesses, which are already FCA-regulated, consumer credit licence-holders may be in a for a shock.

Until now, the main sanction under consumer credit legislation was the threat that agreements might be unenforceable due to non-compliance. Although a whole industry grew up around this, not many defences based on technicalities were successful. The OFT was unlikely to take action unless the whole business model of the licence-holder was objectionable. The OFT’s expectations were set out in guidance notes, which did not have the force of law.

The FCA has said that it will act very differently. It is used to dealing with individual complaints and sanctioning businesses for isolated non-compliance, as well as looking carefully at the overall suitability of a business. It expects rigid compliance and self-reporting of breaches. Directors and those performing “controlled functions” will be subject to personal sanctions, as they are in other FCA-regulated businesses. The FCA will be translating the OFT’s guidance into enforceable rules. There will also be Principles of Business, High-level Standards and Conduct Standards – in other words, a whole new regulatory environment for businesses to learn and understand.

The FCA does promise some relaxation for lower-risk businesses. Giving deferred payment terms at no cost to buyers of goods and services or introducing them to sources of credit, hiring goods to consumers and not-for-profit debt advice all require licensing at present but are to be the subject of exemptions, and there is to be a new status as authorised representative of an authorised firm, allowing businesses to rely on the compliance of their consumer credit supplier.

All licence-holders have to apply for interim permission from the FCA, with applications stating in September, accompanied by payment of a £350 fee – likely to be the first of many. Full authorisation must be applied for by 2016, and aims to  ensure that regulated firms are well-run, recognise the risks they face and have appropriate strategies, systems and controls in place and the right people in important roles. Individuals who perform key “controlled functions” will be vetted and monitored.

Recommended first steps for licensed businesses are to check that your details are correct on the existing Consumer Credit Register and to sign up to FCA consumer credit emails. Any business contemplated consumer credit activities would do well to apply for an OFT licence before April, as otherwise it will be subject to the full rigours of FCA authorisation.

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[1] Financial Services Act 2012 (Consumer Credit) Order 2013

The Takeover Code and unquoted companies

A nasty surprise for the vanity PLC

Changes to the Takeover Code take effect in September. The Code regulates merger and takeover activity, largely between quoted companies. But many people (including many lawyers) do not realise that the Code also applies to some unquoted companies. Complying with it can be onerous: it involves a formal process and detailed documents, as well as large fees to the Takeover Panel. For small companies it is sometimes possible to get a waiver from the Panel with shareholder agreement, but that can be time-consuming and expensive. Otherwise, anyone contemplating buying or selling and unquoted PLC should be aware of the Code and the extra costs and delays it will involve.

Many companies think being a PLC gives them extra kudos. It can make the company seem bigger and more substantial than it is – in reality there may be only £12,500 of share capital paid up. A PLC may find it easier to get trade credit or to avoid needing personal guarantees from its shareholders. That status comes at an expense, because a number of Companies Act exemptions and relaxations do not apply to public companies, but it also brings the company within the scope of the Takeover Code. It applies to takeovers of all public companies (PLCs) whether or not their shares have been traded on a public market.

The Code also applies to a private company which has filed a prospectus, had its shares quoted on a market or had a dealing arrangement for its shares within the last 10 years. An unquoted PLC which has never had a share dealing arrangement can always escape the Code by re-registering as a private company, but any company that falls within the 10-year rule is within the Code for the full 10 year period.

What are the consequences if the Code’s application is missed? First and most likely, it will disrupt a transaction if the Code is raised part way through a deal. It gives minority shareholders in the target company extra rights, so they are the most likely to complain. Failing to comply with the Code is a serious disciplinary offence for parties or advisers in the financial services sector, and can also lead to unregulated companies or individuals being publicly reprimanded or banned from activity in the financial markets. A complaint could be made some time after a transaction. The extra rights conferred on minority shareholders may come as a surprise to a controlling majority, and the extra costs of acquisition could have an effect on potential sale price for the company.

Finally, there is that the dreaded Rule 9: anyone acquiring shares in a company subject to the Code which take him (with his associates) over 30% has to make a cash offer for all the remaining shares. That can come as an enormous shock!

Any unquoted company subject to the Code, and its major shareholders, should be aware of their Code obligations, and perhaps consider whether PLC status is worth it. Do not be caught out when a 29% shareholder buys another 2%, or when the quick and easy takeover deal gets bogged down in process and cost.

It's a privilege to talk to your lawyer

Privilege and withholding embarrassing documents

Are you heading for a legal dispute? Or do you deal with sensitive issues that could be pored over in court later? You should be aware of the law on disclosure of documents and the implications of privilege.

The normal rule in any civil dispute, including tax cases, is that both parties must disclose documents which support or adversely affect any party’s case. Failing to disclose documents, or destroying them (including deleting emails) may be punishable as contempt of court, and can result in the court drawing inferences from the absence of documents you would expect to see. As soon as a dispute starts, your lawyer should advise you on preserving and securing evidence – but it may be too late by then. If the authenticity of documents may be questioned, particularly in relation to emails and electronic documents and records, you may need to get specialist help to preserve forensic-quality copies of the records with their original date and time information.

But what if you don’t want to disclose embarrassing evidence? You may be able to rely on privilege. You are entitled not to disclose privileged evidence, and no inferences can be drawn from your failure to provide it. The courts are fiercely protective of legal professional privilege, which they see as fundamental to our system of justice. Searches (by regulatory authorities, police or under court orders) must be arranged to protect privilege.

There are two kinds of privilege: legal advice privilege, which protects confidential communications between lawyer and client, and litigation privilege. Legal advice privilege covers communications between lawyer and client for the purpose of taking and giving legal advice. It includes documents created for the purpose, but not the client’s background preparations or reactions which are not to be communicated to the lawyer. It applies whether or not there is a contemplated dispute. It includes communications with in-house lawyers (except in EU competition cases) but does not include general business advice which is not given in a legal context.

Litigation privilege covers confidential communications or documents brought into existence for the dominant purpose of use in actual or contemplated litigation, including criminal proceedings or adversarial regulatory investigations, such as competition inquiries by the OFT or FSA investigations. Unlike legal advice privilege, it includes communications with third parties.

Privilege can be waived, sometimes accidentally: if you waive privilege in a document to advance your case on an issue, all other privileged documents relevant to that issue also lose privilege. If you copy documents for some other purpose, privilege may be lost, and it is lost if the documents cease to be confidential. So care is needed to preserve privilege, including appropriate markings: this lies behind the wording often seen on the bottom of emails about privilege.

If your business is dealing with sensitive issues, the last thing you want is for your deliberations to be used in evidence against you. It may make sense to carry out all your internal discussions with or through a lawyer, so that you attract legal advice privilege. No other profession offers this advantage.

Out of court

Problems with expert determination clauses

A very common clause used to establish the value of shares or other assets is defective, according to a recent Court of Appeal decision[1].

Contracts and company articles of association often refer share valuation issues to an independent expert accountant. Similar forms of clause are used to settle the accounts of a business, and in property documents to refer valuations or rent reviews to an independent surveyor. The usual form of clause says that an independent expert is to be agreed or, if not agreed, chosen by the President of the Institute.

In this case the court held that both parties have to agree not only to the selection of the expert, but also to all the terms of the appointment, even if he is chosen by the President. So by withholding agreement to the engagement letter, a party could bring the whole process to a halt. The court said the process should be “formal and precise” and, in litigation that had already lasted four years, would only help by declaring that the parties could not unreasonably withhold consent. This case potentially gives the whip hand to the truculent and unreasonable.

I have devised wording to avid the effects of this case and keep disputes out of court. Anyone who might need to rely on an independent expert clause should have it reviewed before a dispute arises.

Non-disclosure agreements (NDAs, also confidentiality agreements or secrecy agreements) are used in a number of commercial contexts, from deal negotiations to technology sharing. But are they worth the paper they are written on? It is sometimes said that the cost of enforcement makes them useless, at least to small businesses.

There are benefits in having an NDA even if you are not likely to sue on it. Foremost is deterrence, and making the other party more aware of the need to respect confidentiality. The biggest downside, in my view, is not cost but evidence, as it's very difficult to prove a breach and even harder to show loss justifying substantial damages. Injunctions aren't much good if the information has already been disclosed (though they can restrain other abuses). I often advise clients not to disclose their "crown jewels" information even if they have an NDA in place.

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[1] Cream Holdings Ltd v Davenport [2011] EWCA Civ 1287

This article in shorter form was originally written for the
Excello Law Limited newsletter and website

Putting the Djinn back in the bottle

Is an NDA worthwhile?

Non-disclosure agreements (NDAs, also confidentiality agreements or secrecy agreements) are used in a number of commercial contexts, from deal negotiations to technology sharing. But are they worth the paper they are written on? It is sometimes said that the cost of enforcement makes them useless, at least to small businesses.

There are benefits in having an NDA even if you are not likely to sue on it. Foremost is deterrence, and making the other party more aware of the need to respect confidentiality. The biggest downside, in my view, is not cost but evidence, as it's very difficult to prove a breach and even harder to show loss justifying substantial damages. Injunctions aren't much good if the information has already been disclosed (though they can restrain other abuses). I often advise clients not to disclose their "crown jewels" information even if they have an NDA in place.

I drafted one for a client only yesterday, though.

 

Points for Property Professionals 1

Undue influence in lease guarantees  

This is the first of a short series of notes on non-property legal points relevant to property lawyers and others in the property industry.

Landlords of commercial premises often require personal guarantees of the tenant’s obligations. But landlords may not be aware that a guarantee procured by “undue influence” by a third party, even without the landlord’s knowledge, may be unenforceable. This applies to guarantees of leases just as it does to bank guarantees, as the landlords found to their cost in the recent case of Trustees of Beardsley Theobalds Retirement Benefit Scheme v Yardley .

For years now, banks have been aware they need to make sure that guarantors get independent advice where there is a manifest disadvantage to the guarantor in giving the guarantee: Royal Bank of Scotland v Etridge. The bank loses out if the guarantee is procured by fraud or undue influence (for instance of a husband or boss), if the bank should have taken steps to ensure that there was no undue influence. Usually it does that by requiring separate legal advice to the guarantor. But landlords have typically not taken the same approach.

In Beardsley Theobalds the guarantor was an employee of the tenant company. A director falsely represented to the landlord that the employee was a director, and the landlord did not check. The director then got the employee to sign the lease without telling him what it was, and only showing him the signature page.

The judge held that the guarantee was unenforceable. It had been procured by undue influence, and the landlords had not taken precautions against that possibility, such as insisting on independent legal advice. The landlords had “constructive knowledge” of the undue influence, because the landlord was aware of the tenant’s precarious financial position: it was obvious that giving the guarantee was disadvantageous to the guarantor, so the landlord should have been aware of the risk that the guarantor was subject to undue influence. The landlord should also have been aware (though the judge’s reasoning for this is not stated) because the landlord could have checked whether the guarantor was a director. “They should therefore have checked that the proposed guarantor was financially sound, aware of the risks being undertaken and in full agreement with the proposal that he was to guarantee the rent for a fifteen-year period. The guarantor should have been asked to acknowledge in writing that he was fully in agreement to become a guarantor and had been made aware of the risks of signing the guarantee. He should also have provided, through [the tenant], a signed acknowledgement from a solicitor that he had been given appropriate advice before agreeing to sign or a signed waiver of the need to take such advice.”

Unusually, the judge also accepted a defence of “non est factum” (not my deed), available only when the person signing is completely unaware of the nature of the document he is signing. He also allowed a defence to the effect that the guarantor had not authorised the delivery of the deed in escrow, under which it awaited the satisfaction of conditions for two months, which the tenant struggled to fulfil. This last point has wider implications, since parties and their solicitors often fail to consider the authority of parties to deliver deeds and the need for their agreement to any escrow.

The risks to a landlord – or anyone else relying on a personal guarantee – can be reduced by:

·         placing a clear warning just above the signature space about the nature of the guarantee and the need for legal advice

·         putting the guarantee in a separate document (though this could have other implications if it is to benefit the landlord’s successors in title)

·         making sure that the guarantor has a clear financial interest in the tenant company so that the guarantee is not manifestly disadvantageous to the guarantor

·         treating the guarantor as a separate party and not assuming that the tenant or its solicitor has authority on behalf of the guarantor, eg for completion arrangements

·         checking the identity, relationship and financial standing of the guarantor, and his signature

·         insisting that the guarantor gets independent legal advice, providing information about the nature of the liabilities to the legal adviser and getting written confirmation from the legal adviser that he has given the advice.