TUPE reform and the small workforce

Reform of TUPE consultation in the small business

Just occasionally, as your lawyer, I find myself having to advise you to do something really absurd, because an absurd law requires it. One of those is where I am helping you with the sale of your business with, say, just one employee. I have to tell you that in order to comply strictly with TUPE, you have to ask that single employee to elect a representative, for you to consult about the transfer of his employment. You are not allowed to consult the workforce directly, even if you can get all of them round a table in the pub. The collectivist approach is compulsory and elections have to be held, potentially delaying the sale transaction. In practice, most small employers have still carried out direct consultation, but it did not comply with the legislation.

Even in a one-man company, the sole director-employee should supposedly elect himself as representative before he informs and consults himself, in a scene reminiscent of Blackadder in the Dunny-on-the-Wold by-election.

Fortunately that particular absurdity is going, when the proposed reforms to TUPE are enacted. Businesses with ten or fewer than employees will be allowed to consult employees direct, without the rigmarole of elections, where there is no union and there are no existing representatives. However, this will apply only to “micro-businesses”, so the absurdity remains when a larger enterprise transfers a business with a small workforce.

The obligation to inform and consult on a TUPE transfer remains important. Employers have to provide the workforce (or their representatives) with information about the proposed transfer and, when “measures” are proposed in respect of the workforce, consult them. There are no fixed time limits, but the consultation must be a sufficient time before the transfer to enable the views of the employee representatives to be taken into account. Failure to comply with these obligations can result in a Tribunal award of up to 13 weeks’ pay to the affected employees.

The intended reforms to TUPE include a number of other (largely pro-employer) technical changes, but the general principles remain unchanged. The Government has abandoned proposals to abolish the “change of service provision” aspects of TUPE which are probably its most controversial aspect, requiring a new contract or to take on the old contractor’s workforce when a contract is re-tendered.

TUPE gets a bad press, but I am old enough – just – to remember how difficult it was to deal with business and assets sales before TUPE came into force in 1982. There was no means of forcing the workforce to transfer, so the transferring employer stood the risk of redundancy or unfair dismissal claims. On the day of completion, the new employer had to write to all staff offering them jobs on the same terms, which could be accepted by turning up for work on Monday morning. The whole thing was complicated and risky, so the legal process for automatic transfer made things a great deal easier for sellers and corporate lawyers, even if not for contractors and employment lawyers.

Reasonable restrictive covenants

The trend in the cases favours the employer 

The courts continue to take a more employer-friendly view of restrictive covenants in employment contracts (and by extension, in other forms of agreement such as business sales and shareholders' agreements). In Coppage v Safety Net Security Ltd the Court of Appeal was forgiving toward features of the covenant once thought fatal: a non-solicitation clause (an agreement not to poach customers) was upheld even though its wording would include former customers, with no retrospective time limit, and could potentially apply to customers with whom the employee had no personal dealings. The court seemed to be prepared to accept what might otherwise be unreasonable restrictions, if the period for which they applied was short - in this case six months. The short period was a "fundamental consideration of reasonableness" and "a powerful factor in assessing the overall reasonableness of the clause".

The case was about non-solicitation clauses; the attitude to non-compete clauses (excluding the employee from a business sector completely) might well be less sympathetic.

Covenants must always be carefully crafted for the particular situation, but the court will look at the overall facts as much as the wording of the covenant. The law says that the reasonableness of the covenant must be judged when it is entered into, but the court seemed to stretch that rule where it believed the employee had behaved badly and the claimant was a small business protecting a few customers against blatant poaching.

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.

Vendor funding of business sales

a substitute for bank borrowing?

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

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

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

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

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

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

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

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

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

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

 

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

 

Another EMI options tax break

Is this the most generous tax relief we have?

Another big boost for EMI share options: the Treasury has relented and will now extend entrepreneurs' relief - the effective 10% rate of CGT - to almost all EMI options. Previously they had said that the employee would have to hold the shares for at least a year - difficult in many schemes.  From April 2013, the relief will be available if the option (rather than the shares) has been held for a year, and the employee has remained employed for that time.

EMI options are almost ludicrously tax-efficient, with an effective negative tax rate. Any company that could be using them probably should be.

Frequently asked questions:

Why was it hard to get the relief previously? Until the 2012 Budget, entrepreneurs' relief was not available unless the employee had held shares amounting to 5% of the company for at least 12 months. Few EMI options amounted to 5%, so most were excluded on that ground alone. But the 2012 budget removed the 5% requirement for EMI options. The 12 month rule remained.

Why was that a problem? Most EMI options are exercised (converted from an option to real shares) only immediately before the shares are sold. There are a number of reasons for this:

• The employee doesn’t have to find or borrow the money to pay the exercise price
• The employee is not at risk of losing money if the value of the shares falls or the company fails
• If there is tax to pay on exercise (usually only if the exercise price was set at below market value at the date of grant) the employee has the money to pay the tax if he has sold the shares – otherwise he may have it deducted from pay under PAYE
• Option exercise can remain subject to conditions being met. Most popular is condition making options exercisable only when the company is sold – which ruled out holding the shares for 12 months
• The company has not issued real shares until shortly before sale, removing all the issues surrounding small employee holdings in private companies – how to buy the shares back if someone leaves, upsetting voting balance, inhibiting owners remunerating themselves by way of dividends…
• Corporation tax relief is maximised: it continues to accrue on the rising value of the shares until the moment before the shares are sold

Until this change, in order to benefit from entrepreneurs’ relief, the employee would have had to exercise his option and get real shares at least a year before sale. If sale was going to be on sale of the company, that meant accurately predicting an exit a year in advance!

Why is there a negative tax rate?

On options granted at market value, there is normally no income tax (or NICs) payable on grant of the option , exercise of the option or sale of the shares. The only tax paid by the employee is CGT on the gain on sale of the shares, to the extent that it exceeds the annual CGT allowance – and the CGT will now usually be at 10%. But the company gets corporation tax relief on the gain[1], even though it has not incurred any cash cost. As the rate of corporation tax is higher than the employee’s effective rate of CGT, the Treasury is paying you!
 

I have been advising companies on employee share incentives for 30 years. If I can help with EMI options or any other kind of share scheme, do get in touch.








Published December 2012
Updated February 2013

 

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[1] Assuming exercise of the option and sale of the shares are at the same value. All tax reliefs mentioned are subject to conditions, and the tax position described is the usual one, but there could be exceptions; always take proper professional advice, ideally from me!

 

 

Giving up limited liability for accounts exemptions

A new concept in UK company law?

I don’t know whether they achieve the record for the most uses of the word “and” in the title of legislation, but the snappily-named Companies and Limited Liability Partnerships (Accounts and Audit Exemptions and Change of Accounting Framework) Regulations 2012 break new ground in other ways.

As well as simplifying audit exemptions for small companies and making it easier to switch between IFRS and UK GAAP, the regulations grant a subsidiary an audit exemption for its individual accounts – but only if the parent company gives a guarantee of all the subsidiary’s liabilities as at the balance sheet date. There are similar exemptions for dormant subsidiaries from preparing and filing accounts at all. In effect, groups are being invited to give up the limited liability of the individual subsidiary entities as the price for avoiding an audit of the subsidiary’s accounts, or to save the cost of preparing accounts for a dormant subsidiary.

If the subsidiary is material it will have to be included in the parent company audit anyway (though possibly at a higher materiality threshold). The parent company audited accounts have to filed against the subsidiary’s record at Companies House, and there are other conditions to fulfil.

Is it worth it? Parent company directors will want to think very carefully before giving the guarantee. It guarantees “all outstanding liabilities to which the subsidiary company is subject at the end of the financial year to which the guarantee relates”. It includes liabilities not shown in the accounts. Those would include, say:

• future contracted liabilities, eg the rent for the whole of the remaining term of a lease, or costs to complete current sales contracts

• mis-selling liabilities or regulatory fines and penalties

• liabilities of the subsidiary under guarantees it has given to third parties

• product recall or warranty costs

• environmental clean-up costs

• personal injury claims unknown at the time.

Parent companies may not be insured for liabilities they undertake voluntarily by way of a guarantee. Would you want to be the parent company director who exposed the parent company to unknown liabilities to shave a few quid off the audit fee?

 

Trading shares for rights

How will George Osborne’s new share scheme work?

"Workers will be asked to surrender employment rights in return for shares in their company under plans to boost enterprise announced by George Osborne. People who accept the shares will have to waive their rights to redundancy or to sue for unfair dismissal and will not be able to request flexible working hours. The Treasury will not levy capital gains tax when workers sell their shares, which can be worth between £2,000 and £50,000." - Daily Telegraph

 

I don’t wish to enter the political debate on whether employees in small businesses should be able to opt for reduced employment rights, or whether they should have full rights at all. But how would this proposal work on the shares side? I strongly suspect that if it ever sees the light of day, this will be one of those schemes that languishes largely unused – unless it becomes a bonanza for tax avoidance.

 

Of course there are few details available beyond what George Osborne said in his Conference speech. A Government press release adds a couple of points, and promises a consultation, so the promise to “rush through” legislation to be in force by April 2013 looks unlikely to be fulfilled.

So what are the issues that would have to be addressed?

 

·         Under present legislation, the value of the shares (between £2,000 and £50,000 we are told, assuming this means value when they are given) would be immediately charged to income tax, and usually national insurance, when the shares were given. But the new “owner-employee” would have no money to pay the tax, other than his other earnings. Mr Osborne says there will be an exemption from CGT, but doesn’t mention income tax. Will there be an exemption?

 

·         If so, HMRC has been tightening up on employers finding was to confer tax-free benefits on employees, including through employee shares, and this could blow a hole in their strategy. What will stop a senior employee waiving his bonus (and his employment rights) and instead receiving £50,000 in tax-free shares, which he then sells back tax free?

 

·         Further income tax charges can arise if the shares are subject to restrictions or risks of forfeiture. If these rules are waived, further tax planning opportunities open up.

 

·         If the company buys back its own shares within five years of their issue, the gain made by the employee is normally charged to income tax and not CGT, so the promised exemption from CGT looks a bit hollow.

 

·         Most small businesses are very reluctant to part with equity in the company. Minority shareholdings can be a significant brake on the development of the business, especially if they remain after an owner-employee has left and ceases to contribute. But an open-ended commitment to buy shares for cash if an employee leaves would be unaffordable as well as unacceptable. Where is the cash going to come from? Most successful private companies could not easily fund an obligation to buy a significant proportion of their own share value.

 

·         In a start-up micro business the shares are worth very little, so you get an awful lot of shares to make up a minimum market value of £2,000. Entrepreneurs could find they have given away equity that becomes extremely valuable once the business takes off.

 

·         It is an important part of employee share scheme planning to avoid creating incentives for employees to leave. The press release makes it clear that owner-employees must be entitled to full value for their shares and cannot forfeit them as “bad leavers”. This is one of the many attractions of employee management incentive scheme (EMI) options: the employee does not get the shares until their value has been earned.

 

·         Unless a small business is looking for an exit through sale, there will be no visible route for owner-employees to realise their shares except by selling them back to the employer at a valuation. Companies are reluctant to commit to buying shares at someone’s opinion of value. Employee shares can become negative incentives if they fail to grow in value, or if there is no realistic prospect of selling them.

 

 

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.

Click to accept

Are website conditions of use binding?

Many websites have conditions of use, supposedly binding the visitor to various conditions. Usually they are of minor importance, but if they are contractually binding, there is no theoretical limit on the obligations that could be imposed. But is there a contract with the visitor?

Probably not, and a recent case[1] strengthens that view, holding there was no consideration even for an online acceptance click. To form a contract there would have to be offer and acceptance, consideration and contractual intention. None of these is likely to be present just in visiting a website.

The case went further. It held that there was no contract even when the consumer set up an account, registered user details and clicked to accept the terms and conditions. The court said there was still no consideration for the obligations of the consumer: the website owner was not obliged to provide him with any service, and could take down the website at any time. A contract only came into being when an actual order was placed.

That is a surprising conclusion, given the minimal requirements to give adequate consideration, so the case may not be reliable as a precedent in other cases. Including some trivial obligation on the part of the website operator could get round the point.

Less surprisingly, the case also says that attempting to make a consumer responsible for all unauthorised use of his account is unfair and unenforceable under the Unfair Terms in Consumer Contracts Regulations 1999 – see my previous post on that subject, On Level Terms.

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[1] Spreadex Ltd v Cochrane [2012] EWHC 1290 (Comm)

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