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.

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.

Points for Property Professionals 3

Competition law and user restrictions in leases

This is the third in my short series of notes on non-property legal points relevant to property lawyers and others in the property industry. It focuses on the effect of competition law on the negotiation of lease terms.

From April 2011, land agreements (which include leases) lost their blanket exemption [1] under the Competition Act 1998. The Chapter I prohibition in that Act applies to agreements that prevent, restrict or distort competition to an appreciable extent. An agreement that breaches the prohibition is void, and can attract large fines for the parties.

A common form of restriction in a lease that might infringe the ban is the user clause in a retail lease. Leases normally restrict the use of the premises to a particular purpose, which might be broad or narrow.

The effect on competition must be “appreciable”. If both parties have less than a 10% share of the relevant market, the prohibition is not likely to apply (unless there are “hardcore” restrictions such as price fixing). But defining the market can be tricky, and in the case of retail leases the relevant market may be very local. You cannot tell whether a restriction is permitted just by looking at the clause. Also, you can’t judge it only at the date of the lease: a restriction that was valid could become prohibited due to a change in market conditions.

Where both parties are trading in the same market, restrictions are particularly sensitive and should be looked at individually. For instance, where the landlord is a large retailer, letting smaller units on its own retail estate, any restriction on what those units can sell (with a view to restricting competition with the landlord) should be looked at very carefully. Where the parties are potential competitors and the object of a restriction is to share markets by territory, type or size of customer, the agreement will almost invariably infringe the Chapter I prohibition.

If the landlord is not a potential competitor of the tenant, most forms of restricted user clause will not normally infringe the prohibition. The main thing to look for is anything that imposes a restriction on the landlord – usually preventing it from granting leases to competitors of a tenant.

The OFT accepts that restricting use of premises in shopping centres and retail parks is just good estate management, providing a good retail mix. The landlord normally has no interest in restricting competition amongst its tenants, but it wants a thriving estate with a large footfall. Sometimes, though, the landlord will agree not to grant other leases for the same use, or not to permit changes of use, to protect the businesses of tenants from competition. Those restrictions could well be prohibited agreements, if they have an appreciable effect on competition.

However, an agreement is exempt from the prohibition if four cumulative criteria are satisfied:

• The agreement must contribute to improving production or distribution, or to promoting technical or economic progress.

• It must allow consumers a fair share of the resulting benefits.

• It must not impose restrictions beyond those indispensable to achieving those objectives.

• It must not afford the parties the possibility of eliminating competition in respect of a substantial part of the products in question.

The OFT considers that the exemption is capable of applying, for example, where a restriction is essential to attract an anchor tenant to a retail development. The tenant may need to justify substantial investment. Excluding the landlord from bringing in a direct competitor elsewhere in the development could be necessary to achieve that, making the whole development viable and bringing benefits for consumers. But the OFT points out that the restriction should be time-limited, since it must otherwise go beyond what is “indispensable”.

Finally, networks of agreements have to be looked at together. That could include all the leases for one estate, or leases between the same landlord and tenant in different shopping centres across the country.

The OFT publishes a detailed guide to competition law and land agreements on its website.

---

[1] Under the Competition Act 1998 (Land Agreements Exclusion and Revocation) Order 2004 which replaced the Competition Act 1998 (Land and Vertical Agreements Exclusion) Order 2000, revoked by the Competition Act 1998 (Land Agreements Exclusion Revocation) Order 2010.

Points for Property Professionals 2

Property transactions with directors.

This is the second in my short series of notes on non-property legal points relevant to property lawyers and others in the property industry. It focuses on sales or leasing of property between directors and their companies.

Shareholders’ approval is needed for property transactions involving company directors, under section 190 Companies Act 2006. The case law (re Duckwari plc (No 2) [1] and Demite v Protec Health [2] highlights the importance of this section, and the immense potential difficulties if it is not complied with. Property professionals should always be alert to section 190 problems when dealing with transactions involving directors and their companies.

Section 190 applies to an arrangement whereby:

·        a director or other relevant person acquires a substantial non-cash asset from the company or

·        the company acquires a substantial non-cash asset from a director or other relevant person.

The grant of a lease involves the acquisition of an asset, so it is included if the value of the leasehold interest is sufficient.

The value of the asset must be at least £5,000 and exceed 10% of the company’s asset value or, if less, £100,000. Multiple assets in the same arrangement, or a series of arrangements, are aggregated. So, for example, shareholder approval is needed where shown by a tick in the table:

Value of transferred asset(s)		Company Asset Value
	(£100,000) or £10,000	£100,000	£2m
£1,500	●	●	●
£7,500	ü	●	●
£15,000	ü	ü	●
£150,000	ü	ü	ü

A company's “asset value” is the value of the company's net assets according to its most recent statutory accounts, or if no statutory accounts have been prepared, the amount of the company's called-up share capital.

The section applies if the person acquiring or transferring the asset is:

·         a director of the company transferring or acquiring the asset

·         a director of its holding company

·         a person connected with a director of the company or of its holding company.

If the director or connected person is a director of the company's holding company or a person connected with a director, the arrangement must also be approved by a resolution of the shareholders of the holding company, or be conditional upon approval. Connected persons include spouse, minor or adult children, associated companies and trusts.

The acquisition can be direct or indirect, eg via a third party, if it forms part of one arrangement.

If the section applies, the arrangement may not be implemented unless it is first approved by a resolution of shareholders of the company and, where applicable, its holding company. The approval can be given before the arrangement is entered into, or the arrangement can be made conditional upon approval. An ordinary resolution is sufficient, and it does not have to be filed at Companies House.

This section does not require approval:

·       by shareholders of a company which is a wholly-owned subsidiary (but it may still require approval by shareholders of a holding company)

·       of transfers of assets within a group of companies (so long as all relevant companies are wholly-owned group members)

·        of arrangements by companies in insolvent liquidation or administration

·         by shareholders of a holding company in insolvent liquidation or administration

·         by shareholders of a holding company which is not a UK company

·         of transactions with members as such (eg dividends in specie)

·         of transactions on a recognised stock exchange through an independent broker.

The section does apply to sales of assets by liquidators of companies in members’ voluntary (solvent) liquidation, and by receivers.

The effect of failure to comply is:

·        the arrangement, and any transaction entered into in pursuance of it, is voidable by the company, unless for various reasons restitution is no longer possible, or the transaction is affirmed by shareholders; resolution within a reasonable period; and

·       the director involved, any connected person involved and any other directors who authorised the arrangement or transaction are each liable to account to the company for any gain which they have personally made, and jointly and severally liable to indemnify the company for any loss or damage resulting from the arrangement or transaction, even if the arrangement is later affirmed by the shareholders.

In the series of cases of re Duckwari plc it was held that the indemnity for loss and damage is not limited to losses arising from the transaction itself (e.g a sale at undervalue) but also extends to any subsequent loss flowing from the transaction, such as a reduction in value of the asset it acquired. It follows that if the company, without shareholder approval, buys an asset from a director which goes up in value, it keeps the profit, but if the asset value goes down, the company can either avoid the transaction or claim its loss from the directors.

---

[1] [1999] Ch 268

[2] [1998] BCC 638 – sale by a receiver is within the section

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.

What's it worth?

How to value property in shareholder disputes  

To value shares in a company, you often have to value the underlying assets, including properties. But how should a valuer do that? What assumptions should be used? What deductions should be made?

When shareholder makes a successful complaint about unfair prejudice in the way the company’s affairs are run, the court will usually order his shares to be bought out at a valuation, as if the unfair prejudice had not occurred. The court is not bound to follow Red Book valuation principles, but instead has "a very wide discretion to do what is considered fair and equitable in all the circumstances of the case, in order to put right and cure for the future the unfair prejudice which the petitioner has suffered at the hands of the other shareholders of the company."[1] In Shah v Shah [2] the court has given useful guidance on the valuation of underlying assets. The case may well have wider implications, affecting any situation in which a property is being valued when there is no actual intention that it should be sold.

The company’s business was loss-making, so the shares were to be valued by reference to net asset value, but it continued to trade, so there was no likelihood that its property would be sold. As well as deciding items disputed between the expert witnesses, Mr Justice Roth decided that:

1.       The values should not be reduced by the full corporation tax liability that would arise upon disposal. For a property very unlikely to be sold, 10% of the liability should be deducted; for one where there was no sale planned but it was possible, 20%.

2.       Costs of sale, and a contribution to the purchaser’s stamp duty, should not be allowed.

3.       Possible void periods and the weakness of tenant covenants should be reflected in the yield, not separately deducted from the estimated rental value.

The case would make an instructive read for any valuer giving expert advice in court proceedings, and for share valuers incorporating asset valuations into their valuations of companies.

---

[1] Re Bird Precision Bellows Ltd [1986] 1 Ch 658

[2] [2011] EWHC 1902 (Ch)

Property developers personally liable

Insolvency and the single purpose vehicle

Developers should take note of a recent case in which an SPV’s directors were held personally liable for its debts.

It’s a common scenario (or it was, when developments could be funded…). Entrepreneurial developers identify an opportunity. They form a company to carry out the development – a single-purpose vehicle (SPV). They put in some “equity” – more often subordinated debt, or even a limited guarantee of bank debt – and often from a funding partner rather than the personal wealth of the developers. The rest of the money is non-recourse lending from the bank, secured on the property. All the equity goes on land purchase, so the build costs are funded entirely from bank money, advanced against certificates showing that valuable work has been done. There’s a fixed-price building contract with the contractor – though how fixed may not always be clear to everyone.

If it goes well, the bank gets repaid on sale of the investment, or rolls its loan into investment funding. If sale price is greater than land cost plus development costs, the developers walk away with a profit. If it all goes wrong – cost overruns, long void period before sale or letting, fall in market prices – well, from the developers’ viewpoint, they haven’t lost much – the equity  provider loses out, and the bank may take a bath, the contractor loses his retention and the cost of uncertified work, but the developers just go on to another project.

But what if the SPV liquidator cuts up rough? In Roberts v Frohlich and Another [1] the directors were found to have traded after there was no reasonable prospect of avoiding insolvency. They were made personally liable for the build costs after a certain date, on the grounds that this was a breach of duty to the company and wrongful trading [2].

They had juggled the contractor, the bank and a potential buyer of the development, keeping the balls in the air while trying to resolve some fundamental conflicts. The bank’s conditions included a fixed price build contract and pre-sales, but the contractor was insisting on a cost-plus basis and no sales were likely until construction was under way. Neither bank not contractor knew that the other was not yet committed. In the meantime the directors got the contractor to do groundworks and civils under a letter of intent, and had the contractor order the steel for the construction, with no facility in place to pay for them. They drew down a bank facility for the preparatory works whilst knowing that they could not meet the conditions for the development facility. They continued to allow the contractor to run up large costs They knew that the cashflows they and the bank had relied on could not be met. They were driven, in the words of the judge, by “wilfully blind optimism; the reckless belief that… something might turn up.” When the SPV went into administration and the property was sold, the bank got repaid, leaving the liquidator with a fighting fund of £25,000 to pursue the directors on behalf of the unpaid contractor.

Norris J. found the directors guilty of three breaches of duty: (1) the fiduciary duty to the company to act in the interests of the company, which when the company is insolvent or of doubtful solvency or on the verge of insolvency becomes a duty to protect the interests of its creditors; (2) the fiduciary duty to act with reasonable care and skill and (3) the statutory duty [2] not to trade after there is no reasonable prospect of avoiding insolvent liquidation.

(3) is not surprising: directors can be made liable for debts they continue to run up after the point at which they should have called in an insolvency practitioner [2], and an order to that effect is likely in the next stage of  the case. (1) and (2) are a little more surprising: the duty to the company to act in the interests of creditors has been well known, but it has never been clear what liability might attach to a breach. Unfortunately the reported judgment did not deal with remedies, so we are none the wiser.

What lessons can be learned? Directors cannot speculate wildly with other people’s money, even if was willingly lent into a non-recourse vehicle like an SPV. Expect to see more “non-recourse” lenders to companies trying to recover losses through claims against directors.

Don’t incur debts if you cannot be confident that funding will be in place to meet them. Be honest with bankers and suppliers – it is far too easy to slip from hard bargaining into deception. Or, as in this case, self-deception: make sure that the legal documents say what you wish they did.

Remember the shaving-mirror test: is today the day on which insolvency is inevitable?

---

[1] [2011] EWHC 257 (Ch), [2011] All ER (D) 211 (Feb)

[2] Section 214 Insolvency Act 1986