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.

Points for Property Professionals 2

Property transactions with directors.

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

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

Section 190 applies to an arrangement whereby:

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

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

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

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

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

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

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

·         a director of the company transferring or acquiring the asset

·         a director of its holding company

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

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

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

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

This section does not require approval:

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

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

·        of arrangements by companies in insolvent liquidation or administration

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

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

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

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

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

The effect of failure to comply is:

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

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

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

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[1] [1999] Ch 268

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