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

EMI share options boost

By far the most tax-efficient incentive

EMI share options (the Enterprise Management Incentive scheme) were given a huge boost in the 2012 Budget, and they are by far the most tax-effective incentive available to unquoted companies to reward and incentivise employees. Most importantly for the majority of participants, Entrepreneur’s Relief – an effective 10% rate of capital gains tax – will now apply to options exercised after 6 April 2012. That restores the attractions of the EMI scheme before the abolition of taper relief a few years back. Participants with no other relevant gains could receive up to £10m of gains at a 10% tax rate. The overall tax rate is actually negative: the corporation tax relief, at (say) 22%, exceeds the tax the employee pays at 10%. So the Treasury is actually subsidising the benefit.

The limit on the value of options that can be granted to any one employee is also to be more than doubled, from £120,000 to £250,000. The limit applies to the value of the shares at the date of grant of the option. This change is not yet in force, because it requires EU approval as “state aid”.

As a reminder, EMI options give an employee a right to acquire shares at a future date at a fixed price, often the current market value. The right can be conditional: it can be exercisable only on sale of the company, so that the owners do not lose and control or suffer dilution until an exit. Or it can depend on meeting performance targets. The usual tax treatment will be:

·         No tax of any kind on grant of the option

·         No income tax or NI (including employer’s NI) on exercise of the option, if the option is granted at market value

·         The company gets corporation tax relief (say 22%) on the notional gain made by the employee at the date of exercise, even though the company has paid nothing out

·         When the employee sells the shares he or she pays 10% CGT on the gain above the annual CGT exemption (with Entrepreneur’s Relief).

In most cases exercise of the option, issue of the shares and sale of the shares are more or less simultaneous.

The Office of Tax Simplification recently published recommendations for simplifying employee share schemes, including merger of the CSOP into EMI and the introduction of self-certification instead of HMRC prior approval of scheme rules (which is already the process in EMI schemes, greatly reducing cost). But merging the two could bring restrictions on the current freedom of EMI, so it may be wise grant EMI options before that happens.

With private company share values still low in a depressed M&A market, there has never been a better time to grant EMI options. Anyone about to exercise an option should consider deferring until after 6 April. If your company has granted unapproved options to key staff because you had used the £120,000 EMI limit, it may be worth considering cancelling the unapproved option and re-granting it within EMI, especially if the share price has not increased much – but only after the new rules come into force.

I have been advising on employee share schemes for 30 years. If I can help with EMI schemes, give me a call.

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.

 

Charity vaunteth not itself

The new Charitable Incorporated Organisations

Whoever said, “every charitable act is a stepping stone towards heaven” probably didn’t contemplate the Charities Act 2006!

We will shortly have a new form of incorporated body: the Charitable Incorporated Organisation, or CIO, expected to be with us in the spring of 2012. It joins a very select band of forms of incorporation with limited liability. For years we had only the Companies Act company, industrial and provident societies, and companies incorporated by statute or Royal Charter; in recent years they have been joined by the open-ended investment company (OEIC), the LLP, the community interest company (CIC), the European EEIG and SE, and now the CIO.

For many years it has been common for charities to be registered as companies, not least to get limited liability for the trustees. The relationship between charity and company law has always been a little tense, and it started to become necessary for the Companies Act to make special provision for charitable companies. Now it has been realised that it makes more sense to have an entirely separate form of incorporation for charities, overseen by the Charity Commission rather than Companies House and the BIS.

There have been long delays in bringing the new legislation into force, but the latest information is that should be in by the spring – though there is some scepticism about whether this timetable will be kept to. To avoid a logjam of applications, existing charitable companies may not be allowed to apply until later. There will be a procedure for converting existing companies to CIOs, so there will be no need to transfer assets from the old company to the new CIO – though that will still be needed to turn an unincorporated charity into a CIO.

Charities with complicated governance structures or membership schemes would be well advised to start drafting their new constitutions now, if they want to take up the new format as soon as it becomes available. More information is on the Charity Commission’s website. The legislation setting out much of the detail on how CIO’s will work (which is not yet in force) is in Schedule 7 to the Charities Act 2006.

Say Cheese©!

Reproducing the composition of a photograph

I’m an amateur photographer, so I found a recent copyright case interesting: Temple Island Collections v New English Teas – about images of London on tasteful souvenirs in tourist shops. A photograph taken of the same general (but not exact) location and subjected to similar digital manipulation as the original was held to infringe copyright, even though no part of the original was physically copied. The two pictures are reproduced in the judgment or here.

The case stretches copyright towards protecting the creative thought rather than the result. Traditionally it is said that copyright protects the expression of the idea rather than the idea. The problem with protecting the idea, as the judge himself recognised, is where the principle stops. It doesn't stop someone taking a picture from the same vantage point, or converting an image to black and white, or using spot colour on a black and white (which the claimant admitted he has copied from Spielberg’s Schindler's List), or blanking the sky; but at some point doing all these things together, inspired by an earlier work, became copyright infringement.

Would any two, or any three of those factors have been sufficient? If I photograph four of my mates crossing Abbey Road, is that copyright infringement? What if I have one of them take off his shoes? The case contrasts with Creation Records and Noel Gallagher v News Group Newspapers in which The Sun’s photographer did not infringe copyright by snapping an elaborate photo-shoot set from the same position as the official photographer.

I think the new decision is right - after all the reproduction of other forms of work, such as a musical score, does not require mechanical copying, and copying in a different medium can be an infringement. If I made a painting from the photograph (which would be a very poor reproduction!) I would be infringing, so why not if I deliberately re-create a photograph? But it does make it hard to draw the boundary.

Help! The bank has frozen my account!

Collateral damage from money-laundering legislation

I have seen this more than once: a client rings in a panic, having had his business bank account frozen by the bank. His bank won’t tell him why. They are suddenly completely uncooperative, and he is naturally livid. He wants to know how to get the account unfrozen, and if necessary to take immediate legal action. What should you do if it happens to you?

The reason is almost always that the bank has formed a suspicion that the account or the customer is involved in money-laundering (or terrorist financing). Once it forms that suspicion, the bank is obliged by law to block transactions; otherwise it risks committing an offence of converting or transferring criminal property under the Proceeds of Crime Act 2002 or facilitating the retention or control of terrorist property under the Terrorism Act 2000. [1] It also has to make a report to the Serious Organised Crime Agency (SOCA) explaining its suspicions.

You may be an entirely innocent party. The suspicion could relate to an investor, employee, customer or supplier. The concept of “proceeds of crime” is extremely wide, and can include, for instance, the benefit of tax evasion, or business cost savings arising from minor offences.

Suspicions can be triggered by the bank’s internal systems, far away from your relationship manager. All banks now operate back-office systems for flagging up and reporting unusual transactions. Your manager might know why something has happened, but it may still look suspicious to someone – or a computer – in head office.

What is more, the bank is prevented from telling you why it has done what it has done: it is an offence to “tip off” a person if that could prejudice an investigation following the report. The only way to avoid lying to you is for the bank to say nothing at all, so it just clams up. Of course this can be a nonsense: any criminal or terrorist, and most well-informed people, will know that if a bank or professional adviser suddenly refuses to act on instructions and won’t tell you why, it is probably because they have a made a money-laundering report.

SOCA can give consent to allow transactions to proceed, or if it doesn’t respond within seven working days, the freeze ends. But if SOCA refuses consent, the freeze is extended until 31 days from the date of refusal of consent. In that case, SOCA will usually have notified the police or other enforcement agencies. If they want further time to investigate, they will have to make an application to court.

The courts have consistently supported banks when they have relied on their duties under the money-laundering legislation, even if the customer is entirely innocent. [2] So the customer usually has no remedy, even if his business is left in ruins. A Mr Shah has been claiming losses of $330 million from HSBC which he alleges flowed from their blocking of transfers from his account.

To be protected, the bank just has to satisfy the court that it had a suspicion. The suspicion does not even have to be reasonable: if the bank has a suspicion, it must report and it must stop the transaction. The court has said that the bank must “think that there is a possibility, which is more than fanciful, that the relevant facts exist. A vague feeling of unease would not suffice. But the statute does not require the suspicion to be 'clear' or 'firmly grounded and targeted on specific facts' or even based on 'reasonable grounds'." [3]

Mr Shah tried a variety of different attacks on the bank’s position. He said that the bank’s suspicion was irrational; negligently self-induced; mistaken; and/or automatically generated by computer. He said that the bank was negligent, or breached its duty to give him relevant information about his affairs. The Court of Appeal dismissed all these claims apart from the last. It allowed the claim to go forward only in case Mr Shah could prove that the bank did not in fact have a suspicion at all; or he could prove loss from the bank’s failure to tell him what was going on, at a time when it was not protected by the “tipping off” requirement – perhaps because the investigation had ended. In a second visit to the Court of Appeal, the court even refused to order the bank to tell Mr Shah which employees had the suspicions and made the reports, on grounds that it was not relevant; public interest immunity could also apply.[4] Mr Shah’s lawyers made a third unsuccessful visit to the Court of Appeal [5] before the remains of his case came on for trial in December 2011. The trial is still going on, with a decision not expected for several months, but the legal principles are clear.

So what advice do I have for the innocent bank customer, without the resources of Mr Shah, to fund costs? Each case depends on its facts, but early litigation is not likely to be successful. In the short term, the best answer is usually to work with the bank to allay the suspicion and get the freezing lifted. If the client thinks he knows what has caused the suspicion, give the bank the evidence. Ask them to seek the permission of SOCA to proceed with the transaction, as a matter of urgency. Whilst pointing out the possibility of a claim may focus their minds and make them review their decisions, it is unlikely that there will be a successful claim if there is a genuine suspicion. Bank customers should perhaps be alive to these issues beforehand and try to head them off, for example by giving the bank an explanation in advance of transactions that may look suspicious. As Mr Shah is finding out, the cards are heavily stacked against the customer.

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[1] It could also be that t has not completed its client due diligence under the Money Laundering Regulations 2007 or its ongoing monitoring has noticed a problem with it, which can oblige it to block bank account transactions under Regulation 11.

[2] K v National Westminster Bank; R (UMBS Online Limited) v SOCA; Shah v HSBC Private Bank [2010]

[3] R v Da Silva

[4] Shah v HSBC Private Bank [Oct 2011]

[5] Shah v HSBC Private Bank [Nov 2011]

Stephen Hester’s bonus: how not to structure exec remuneration

Tax and bonuses in shares

Sorry if you’re expecting a polemic about the level of bankers’ bonuses. There’s been far too much of that in my view: I have the old-fashioned view that if the Government negotiates a contract it’s probably not a good thing for it to renege on it.

What I wanted to tell you about is the tax treatment of such a bonus, and how smaller companies can do much better. This is an area in which those poor oppressed bankers really have been losing out.

The Government has been keen to see bonuses paid in shares rather than cash, but it has made no tax concessions to encourage it. An employee receiving free shares as a bonus is taxed on their value as if they were cash. Listed company shares are “readily-convertible assets” so the tax has to be paid through the PAYE system, and national insurance is payable. Mr Hester is not allowed to sell his shares, so he will have to find over £500,000 out of his net salary to pay the tax on his £963,000 bonus. On his reported salary of £1.2 million, that will leave him with about £85,000 net [1]. The taxpayer-controlled bank will have to pay national insurance contributions of almost £300,000. So in total for 20011-12 Stephen Hester gets £85,000 and George Osborne gets £1.425 million! RBS does get a corporation tax deduction for the salary, the value of the shares and employer’s NIC (if RBS makes a profit) but the Exchequer still gets £785,000 net.

The position changes, of course, when the shares are eventually sold. If they go down in value, there is no tax to pay, but no credit for the tax already paid. If they halved in value, Mr Hester would make a net of tax loss (the tax paid would be more than the proceeds of sale). If the shares go up, there is no tax on the first £963,000 (on which he has paid tax already) but the profit will be chargeable to capital gains tax. But of course the taxpayer loses out through dilution of the Treasury’s shareholding: if the shares double in value, the bonus will have cost the shareholders twice as much as if they had paid the bonus in cash.

Mr Hester may be able to afford to pay £520,000 of tax and NIC out of other salary and resources, but most employees are not likely to be grateful for a bonus in shares they can’t sell, which lands them with a large tax bill they can’t pay. This makes bonuses in shares very unattractive.

Fortunately private companies have a much better route available to them. We can thank the LibDems (in the 1970’s [2] for starting a range of tax-approved employee share schemes. Best of these now is the Enterprise Management Incentive (EMI) Scheme [3]. Its tax advantages remain amongst the best of any tax relief. Complete exemption of gains from tax or NIC and a full corporation tax deduction for the value of the shares mean the net tax rate is often actually negative!

I have been setting up EMI schemes for private companies for many years. They are wonderfully flexible, and can be structured to avoid diluting owners’ equity until the company is sold. If you would like more details please contact me.

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[1] assuming he uses his allowances and basic rate tax band elsewhere

[2] actually they were still Liberals then

[3] under Schedule 5 of ITEPA 2003

A tax windfall for solicitors?

Make a back claim for VAT bad debt relief

An extraordinary VAT case that could be worth a lot of money to solicitors: if you issue a VAT-only invoice to your client and the client fails to pay, you can claim VAT bad debt relief and get the full amount back, not just a proportion representing the VAT rate.

This arises when someone else is paying the costs, but your client is VAT registered and can reclaim VAT on your fees. You bill the client for the VAT element and send a non-VAT invoice to the third party, who pays the net of VAT costs. Most often that is the client’s insurer paying your litigation costs, but it could also be a tenant paying a landlord’s costs, or the losing party in litigation paying the winner’s lawyer’s costs. But what if your client fails to pay the VAT? You may have difficulty recovering it; if you were instructed by the insurer you may have no real relationship with the client, and you will not have been able to do credit checks or get money on account.

Previously it was assumed (and case law said) that you had to treat this like any other bad debt, and the fact that you had issued separate invoices for the fee and the VAT was irrelevant: you had (at 20%) recovered 5/6^th of your VAT-inclusive fee so you claimed bad debt relief on 1/6^th, and got 1/6^th of that back, or 1/36^th of the total; you were out of pocket by 5/36^th. In Simpson & Marwick v HMRC[1] the Upper Tribunal said this was wrong: if the bad debt is clearly identified as the VAT element, it can be claimed in full – HMRC loses the entire 6/36^th.

It is worth reviewing records and talking to your accountants about making back claims for relief. The case could yet be appealed so make appropriate disclosures in any claim.

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[1] [2011] UKUT 498 (TCC)

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.

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[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.

Should the insurers pay?

Business insurance in the light of the PIP implant scandal

In recent discussions about the PIP breast implants scandal, many people have asked why PIP’s insurers are not paying for replacement of the implants. It may be a good time to remind readers about the different types of business insurance for third party claims, and how they might respond to a product liability claim.

Leaving aside employer’s liability insurance and motor insurance, the most common form of liability insurance is public liability insurance. It covers injury to persons or property arising from business activities, which will normally only arise at the company’s premises, or on others‘ premises when visiting them. Liability for defective products will not be covered, nor will obligations under contracts. I am sometimes bemused by the common requirement in public sector contracts for a minimum level of public liability insurance: there is often woeful ignorance of what is likely to be covered by such insurance, and so long as the contractor can produce a certificate showing he has insurance for a sufficiently large amount, the likelihood of being able to claim doesn't get questioned. The chances of a claim by contract counterparty under public liability insurance are extremely small.

Basic product liability insurance covers injury to persons or property arising from defective products. It does not cover repair or replacement of the products themselves. That would normally require product recall insurance, which is much rarer.

Finally, professional indemnity insurance covers liability for negligent advice or negligent design.

Unless it is required in a particular industry – for instance solicitors must have professional indemnity insurance – and apart from employer’s liability and motor insurance, none of these types of insurance is compulsory, so any given supplier may not have it, or may not have sufficient cover.

To get the benefit of the insurance, the third party claimant first has to establish her claim against the insured business. In most cases there must be a legal liability – for example liability for a defective product under the Consumer Protection Act 1987. The outcry over PIP breast implants is far short of proving that any particular implant is defective or has caused harm. In the PIP case the claimant could be the patient trying to claim direct against the manufacturer, or could be the buyer of the product from PIP wanting to recover its own loss if it compensates its patient or customer.

Insurance usually exists to protect the policy-holder, and third parties normally have no direct right to claim under it (motor policies are different). It is up to the insured business to decide whether to claim on its insurance, and the policy will be subject to limits and exclusions, or may be void for breach of conditions or non-disclosure – eg if the insured manufacturer had deliberately used sub-standard materials. A common condition of product recall insurance excludes recalls forced on the manufacturer by government or a regulator – to prevent authorities passing liabilities to insurers they would not otherwise have, perhaps under the pressure of a public scandal.

The position changes slightly where the policy-holder has become insolvent. Its rights are transferred to the third party claimant under the Third Parties (Rights Against Insurers) Act 1930 (to be replaced by the 2010 Act when the Government decides to bring it into force). Both Acts invalidate a condition terminating liability on insolvency, and the new Act will remove the need to sue the insolvent company. The Acts prevent the proceeds of the insurance claim falling into the insolvent estate and being distributed to the creditors generally.

Insurance written on a "claims made" basis requires a claim to have been made while the policy was in force. If no claim was notified to the insurer during the policy period, no claim can be made subsequently. Product liability insurance may be on a "claims made" or "claims arising" basis. So the insurance could have expired before the third party makes her claim, especially if the business has ceased trading and stopped paying premiums.

In the case of a foreign manufacturer, the policy terms may well be under foreign law, though the Third Parties (Rights Against Insurers) Act probably applies to UK claimants against the foreign insurers after insolvency, if the foreign law would not allow them to claim.

Further reading: a good explanation by Airmic of business insurance generally, including the different types of cover, is here. An excellent summary of the law on product liability and product recall insurance by Herbert Smith is here.

A new kind of deal for 2012?

Buying companies with cash at bank

You only find out who is swimming naked when the tide goes out, as Warren Buffett said. No-one wants to be vulnerable to further economic shocks. Since 2008, companies have been rebuilding their balance sheets. Many successful companies have built up significant cash reserves. They remain reluctant to invest in major expansion or in acquisitions.

Professionals in the M&A market have been waiting for confidence to return so that companies start to spend this cash on acquisitions. But the continuing Eurozone crisis means that no-one is buying, despite the many businesses available at bargain prices. Lack of demand the absence of bank funding for acquisitions keeps values low, even though many businesses are making good profits.

But will we see a new type if deal emerging in 2012: acquisitions funded partly with the target’s own cash?

Cash-rich companies make juicy low-risk acquisition targets for buyers who might be slightly more vulnerable, or for those looking to expand. Selling a company with its cash is highly tax-efficient for vendors. The legal rules banning financial assistance by the target have largely been abolished. If the price is deferred or settled in paper, or at a discount to the cash, the deal can become partly self-financing.

Wishing all bargain-hunters, keen sellers and market professionals a prosperous 2012.