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They can't win your raffle unless they buy a ticket... or can they?

The story of Dunstan Low, who successfully raffled his £845,000 Lancashire mansion by selling 500,000 raffle tickets,[i] is another example of the re-appearance of the earlier trend for homeowners who have lost faith in the traditional method of selling their homes to raffle them instead. On the face of it, this looks a great idea. If you charge £2 a ticket and your property is valued at £500,000, then you need only sell 250,000 tickets to recover the full value, plus some extra tickets to cover your costs. In theory, you shouldn’t be short of entrants to your raffle either, as the odds aren’t bad and the prize a chunky one.

In practice, it’s not quite that easy. Several house sale raffles and competitions have failed to achieve sufficient ticket sales and had to refund entry fees or pay a smaller cash prize instead. Potential entrants may ask why the house hasn’t sold by the traditional route, and be wary of acquiring a property without the usual investigation of problems and associated costs.

Anyone thinking of raffling their house should also be aware that the Gambling Act 2005[ii] makes it a criminal offence to run a lottery without a licence – and licences are only available to charities (and local authorities) as raffles can only be run to raise funds for good causes. There are some limited exemptions for things like raffles to raise money for charities and workplace sweepstakes, but these won’t apply to house sale raffles (even if you give part of the profits to charity). Whilst the law in this area is complex and advice should always be taken, there are two ways to differentiate your scheme from an illegal lottery. Firstly by requiring entrants to use skill, judgment or knowledge so that the winner isn’t chosen by chance, or secondly by giving entrants the option of participating for free.

Questions will only satisfy this “skill test” if they require sufficient skill, judgment or knowledge to prevent a significant proportion of entrants answering correctly (or entering at all). Of course, those who get the answer wrong must not be entered into the draw. If there’s any doubt whether the questions are sufficiently challenging, you would be wise to offer an alternative free entry route too – even though this seems counter-intuitive when you’re trying to raise money.

The free entry route can be ordinary (first or second class) post (but not special delivery), or telephone at ordinary rates (but not using a premium number), or any other method which doesn’t involve any additional expense reflecting the chance to enter the raffle and is as convenient to the entrant as the paid route. The free route can’t be “hidden away”, and of course free entries must have the same chance of winning. The Gambling Commission offers useful guidance, on both the skill test and free entry routes, on its website[iii] as well as a recent update on house sales[iv].

For more information regarding raffles and skill competitions please see our article “Healthy competition: your legal how-to guide for the sporting Summer” and do take legal advice if you are considering running a raffle, whether to fund-raise for charity or to sell your house. If you fail to negotiate the legal pitfalls correctly, you may have to close the scheme and refund all the ticket sales – and could be fined (or even imprisoned) for committing a criminal offence.

Commercial Agents: Diamonds are not forever

So said Popplewell J in the opening line of his judgment in the recent case of W Nagel (a firm) and Pluczenik Diamond Company NV[1].  The judgment is an important one for companies involved in the sale and purchase of commodities, in that it appears to be the first case to consider the scope of the exemption under the Commercial Agents (Council Directive) Regulations 1993 (Regulations) for commercial agents who operate on commodity exchanges.  However, some aspects of the judgment are of broader application to agency relationships, and will be of interest to all businesses that appoint or operate as agents in the UK.   

Background

The case involved a claim by Willie Nagel (WN), a diamond broker, against his client, Pluczenik Diamond Company (one of the world’s leading diamantaires), for termination of an agency relationship involving the purchase by Pluczenik of rough diamonds from De Beers.

WN was appointed by Pluczenik as its broker in the 1960s, and continued to act as Pluczenik’s agent in relation to the purchase of rough diamonds at De Beers ‘sights’ (one of the main channels by which De Beers sold rough diamonds into the wholesale market) in the UK up until 2013.  In 2013 De Beers moved its global sight from London to Botswana, prompting Pluczenik to terminate its relationship with WN.

WN claimed that he was a ‘commercial agent’ under the Regulations, and therefore entitled, under Regulation 17, to compensation on termination of the agency relationship.  Pluczenik disputed the claim on the grounds that the Regulations did not apply. 

Did the Regulations apply?

Regulation 2(1) defines a commercial agent as “a self-employed intermediary who has continuing authority to negotiate the sale or purchase of goods on behalf of another person (the "principal"), or to negotiate and conclude the sale or purchase of goods on behalf of and in the name of that principal …."

Pluczenik claimed that the Regulations did not apply on two grounds: first, it argued that WN did not have authority to negotiate on its behalf and did not, therefore, satisfy the requirements of Regulation 2(1), and second, it relied on an exemption in Regulation 2(2)(b) which provides that the Regulations do not apply to “commercial agents when they operate on commodity exchanges or in the commodity market”.

Authority to negotiate

On the first of these two grounds, the Court found that, because the purpose of the Regulations is to give agents a share of the goodwill they generate in a principal’s business, the key question in determining whether a person is a commercial agent under the Regulations is whether the scope of his retainer includes the development of goodwill in the principal’s business.  This is a more relevant consideration than whether an agent actually participates in discussions on price or commercial terms.

In the Court’s view, WN had developed strong relationships with senior executives at De Beers, and had used these relationships to promote Pluczenik’s interests, fostering a relationship of trust and confidence between Pluczenik and De Beers, which contributed to the success of Pluczenik’s business.  WN therefore had authority to negotiate within the meaning of Regulation 2(1).

Interestingly, and somewhat surprisingly, the Court also considered that administrative functions such as invoicing, payment, packaging and transport helped maintain Pluczenik’s goodwill with De Beers, and that this was also relevant to the decision that WN was a commercial agent within the meaning of Regulation 2(1).  This potentially has implications for businesses that appoint third parties to provide logistics and shipping services.

Commodities exemption

In determining whether there is a sale on a commodity exchange or commodity market (so that Regulation 2(2)(b) applies), the Court’s view was that the focus should be on the manner and place of sale as well as the nature of the goods sold. 

In the Court’s view, the concept of a commodity sale generally (though not always) focusses on generic goods in bulk, which are indistinguishable in origin or features from other goods of the same type, and that “where generic goods are bought by description, that is a pointer towards their being bought as commodities, but the opportunity to inspect [the goods before purchase] is not fatal to their being so”.

The court held that sales of diamonds in boxes at the De Beers sights were sales on the commodity market on the grounds that: (i) it was a wholesale market in a single class of unprocessed minerals, (ii) the boxes were sold by category and description and at a fixed price, and contained a standardised selection of stones by category, (iii) the boxes were largely traded unopened and sight unseen, and (iv) the proportion of the world’s rough diamonds sold at De Beers sights (while varying over time) was always a very substantial proportion. 

On that basis, WN was not protected by the Regulations.

The Court specifically rejected the argument by Pluczenik that, in order to be a commodity, the goods in question had to be the subject of futures and options trading.

Secondary Activities

The Court also considered, briefly, the application of Regulation 2(3), which excludes from the Regulations agents whose activities are ‘secondary’.  This part of the judgment, although brief, is noteworthy in that it is one of the few cases in which an English Court has considered this exclusion.

The Court concluded that, if an activity which the agent is engaged to perform falls within the Regulations, but is secondary to another activity which the agent is engaged to perform which falls outside the Regulations, then the agent should not be regarded as a commercial agent. 

This is a useful, albeit brief, judicial clarification of what is an unclear and convoluted part of the Regulations.

How much notice of termination must be given?

Although the Court did not need to consider the issue (as it concluded that Pluczenik had no grounds to terminate the agency relationship), it nevertheless gave its views on the key factors to be taken into account in determining what constitutes ‘reasonable notice of termination’ of an agency agreement where the Regulations do not apply[2] and no notice period is specified in the agency agreement. 

These factors include: (i) custom and practice in the relevant market, (ii) the length (and formality) of the relationship, (iii) the agent’s ability to make adjustments for loss of the agency, (iv) the notice period required had the Regulations applied, and (v) the nature of the agent’s obligations. 

Weighing up each of these factors in the present case, the court concluded that a minimum of 3 months notice (or two ‘sights’ if longer) was reasonable in the circumstances.

Compensation

Finally, the Court considered how an agent’s compensation for wrongful termination of an agency relationship should be calculated where the Regulations do not apply.  The Court concluded that damages are to be calculated in the same manner as a claim for compensation under Regulation 17[3] (even if the Regulations do not apply) with the important exception that any costs saved by the agent as a result of the termination of the agency should be taken into account when assessing a claim for damages under common law.

Conclusion

As noted above, although this case is of particular relevance to businesses operating on commodity exchanges and in the commodities market, it is of broader application to other businesses which use or operate as agencies.

Businesses operating on commodity exchanges and in the commodities market should review their existing agreements with brokers and agents to assess whether the Regulations are likely to apply.  Where they are likely to apply, businesses should consider taking steps to minimise their financial exposure on termination of these arrangements, including consideration as to whether it is better to agree with their agents that, where the Regulations apply, any payments on termination will be calculated on an ‘indemnity’ basis (where payments are capped at 1 year), rather than on a ‘compensation’ basis (where no cap applies).  Companies should bear in mind that, where an agreement is silent on which of the two alternatives apply, the uncapped compensation alternative applies by default.

In light of the Court’s view that purely administrative functions such as invoicing, packaging and transport can contribute to the goodwill between a principal and his customers, businesses who outsource any of these functions to third parties should likewise review their agreements with those third parties to assess the likelihood of the Regulations applying (particularly where the third party also contributes to goodwill in other ways) and the need to take steps (as outlined in the preceding paragraph) to minimise their financial exposure on termination.

Where an agent’s activities include activities that fall within the Regulations, and those activities are secondary in nature to other activities which are not caught by the Regulations, agents and principals should consider whether it is in their interests to include both sets of activity in the same agreement.  (The judgment in this case would appear to suggest that it is in a principal’s interest to cover both activities in the same agreement.)

The decision is also a reminder of the importance of ensuring that the key terms of an agency relationship, particularly one that is not governed by the Regulations, are agreed between the parties and properly documented.  These include termination notice periods, the grounds upon which the agreement can be terminated, and the basis of calculation of commission payments, including the extent to which an agent is entitled to commission on sales or purchases that are concluded after termination of the relationship where the agent has played a role, pre-termination, in those sales or purchases.

For further information on this article or agency or distribution agreements generally, please contact Paul O’Hare.

 

[2] Where the Regulations apply, an agent is entitled to one month’s notice per year of the agency agreement, up to a maximum of three months.

[3] According to the House of Lords decision in Lonsdale v Howard & Hallam Ltd [2007] 1 WLR 2055, compensation under Regulation 17 should be calculated by reference to what a hypothetical purchaser would pay for the agent’s business (assuming the agency had continued and not been terminated).

Nesta announces Open Up Challenge participants as CMA deadlines edge closer

Nesta, the innovation foundation, has announced the twenty organisations selected to participate in the Open Up Challenge.  The total prize pot is worth £5m and shall be shared amongst those participants offering the best solutions to SMEs seeking access to financial services and products, by harnessing the power of open banking APIs.

Participants are given exclusive access to the Open Up Data Sandbox containing anonymised transaction data relating to SME’s bank accounts.  This allows the participants to develop their platforms in anticipation of the government and CMA-backed scheme to standardise open banking APIs through which intermediaries will be able to access live SME transaction data in order to provide tailored services, such as credit scoring, financial intelligence and recommended lending products.

The Challenge is divided into two stages, the first of which culminates in the selection of up to 10 of the 20 participating teams, who will share in a £1m prize pot, to be chosen in December 2017.  The second stage continues through 2018, with prizes awarded in April and in September, with a further £2.5m available.

How does this timeline fit in with the open banking rules published by the CMA this year, requiring major banks in Great Britain and Northern Ireland to collect and make available a series of open and closed datasets?

CMA’s retail banking market investigation

In February 2017, the CMA instructed major retail banks in the Great Britain and Northern Ireland to make available reference information relating to certain standardised business and consumer products, and customer transaction data.

This followed a market investigation, which was carried out, between 2014 and 2016, following which the CMA published its report in November 2016. The terms of reference for the investigation included the consumer market for personal current accounts (including overdrafts) and the SME market for business current accounts, overdrafts, deposit accounts and lending products. The market investigation considered whether any feature, or combination of features, of the relevant markets prevents, restricts or distorts competition and, if so, what action should be taken.

The CMA’s report identified three types of lending products that suffer adverse effects on competition (AECs), as follows: (i) business current accounts; (ii) SME lending; and (iii) personal current accounts.

The Open Up Challenge represents part of the CMA’s response to the first and second of these AECs, that response being to facilitate the Challenge in order to stimulate directly innovations which would counter the lack of competition in business current accounts and SME lending. Such innovations are likely to include services which use the open banking APIs (see points 1 and 3 below) to allow for easier comparison between banking services through data aggregation and analysis – an activity which will be regulated and facilitated under the new PSD2 payment service category of “account information service provider” or “AISP”.

CMA open banking deadlines

The scope of the CMA rules are broader than SME lending, as they also cover consumer banking, but many of the rules are relevant to the Challenge since they are designed to help innovators such as the Challenge participants to reduce or eliminate AECs in relation to key banking services.  The main rules (affecting both business and consumer banking services) are set out below, and require banks to

1.release specified reference and product information, without charge or restriction (and which will be accessible via open banking APIs), no later than 31 March 2017, including:

 (a) reference information, including:

    (i)            branch locations and opening times;

    (ii)           ATM locations;

 (b) product information relating to personal current accounts and business current accounts and SME lending products, including:

   (i)            product prices (including credit interest);

   (ii)           fees and charges, including interest rates;

   (iii)          features and benefits;

   (iv)          the monthly maximum charge;

   (v)           terms and conditions;

   (vi)          customer eligibility criteria.

2.  specify the maximum monthly charge that could accrue on a personal current account from 2 August 2017.

3. publish rates for SME lending products (the APR for unsecured loans up to £25,000 and the EAR unsecured standard tariff business overdrafts up to £25,000) by 2 August 2017.

4. make transaction data from business current accounts and personal current accounts continuously available from the date PSD2 comes into force, being 13 January 2018.

5. collect feedback from their customers as to whether customers would recommend their banking products to others, no later than 15 January 2018.  Banks must release this data, as “service quality indicators”, from 15 August 2018.

6. automatically, and free of charge, provide transaction data relating to business current accounts and personal current accounts which are closed by the customer (covering the last 5 years’ of transactions) from 2 February 2018.

7. standardise business current account opening in terms of the information required from applicants (such as identification requirements) from 2 February 2018.

8. enrol personal current account holders into an alerts programme under which consumers are notified that they have exceeded or will exceed a pre-agreed credit limit, from 2 March 2018.

9.  offer a tool on the bank’s website enabling SMEs to obtain indicative price quotations and their eligibility for unsecured business loans and/or unsecured standard tariff business overdrafts, each up to £25,000, from 2 February 2018.  The same tool should be accessible to a minimum number of third party intermediary service providers by 2 May 2018.

Please note that these obligations apply to certain types of banks and credit products with a number of applicable exceptions.

Businesses seeking to exploit these rules should move quickly to ensure they are best placed to make the most of the opportunities they present. Banks, on the other hand, should already be working behind the scenes to ensure compliance with the deadlines set out above – some of which have already passed, and others will require significant preparation.

Equally, those seeking to take advantage of the open banking APIs to provide “account information services” from 13 January 2018 need to be registered to do so with the FCA – the application process for registration opens on 13 October 2017.

More information

For more information on the launch of the Open Up Challenge and Kemp Little’s role as its legal advisor, please click here.

For more information from Nesta on the Open Up Challenge, please click here and here.

Gambling Advertising: The Gambling Commission's revised enforcement strategy

The spotlight continues to fall on gambling advertising. All operators must comply with licence conditions and codes of practice which require them to make clear any conditions which apply to promotions and to comply with the Advertising Standards Authority’s CAP and BCAP codes of practice. Recent rulings by both the Gambling Commission and the Advertising Standards Agency (ASA) have made clear that compliance is an issue for both gambling operators and their affiliates and marketing agencies.

In May, BGO Entertainment was fined £300,000 for adverts which were found to be potentially misleading as they failed to make clear the conditions surrounding promotions. The fine related not only to adverts on BGO’s own website, but also to adverts which had appeared on its affiliates’ websites. BGO’s failure to take effective action to address these breaches of its licence raised doubts about its suitability to carry out its licensed gambling activities.

In February, the ASA upheld a compliant about a Lottoland radio advert which failed to make clear to players that they were betting on the outcome of lotteries, rather than participating in a lottery. In June the Gambling Commission also fined Lottoland £150,000 for failing to make this distinction clear in its third party marketing, website and social media promotions. The distinction is important because part of the proceeds of a lottery must go to good causes.

These advertising rules aren’t new – but the Gambling Commission’s approach to enforcement perhaps is. In its “Raising Standards” conference in November 2016, the Commission stressed that advertising was a focus area, operators are responsible for their affiliates’ actions, and the Commission was ready to take action, and it repeated this message at the ICE gambling expo in February.

On 5 July the Gambling Commission published its revised enforcement strategy which confirms the approach we are already seeing in practice. Three key points are:

  • The Commission will use all its enforcement powers – there is no longer a bias towards settlement, so licence reviews are more likely.
  • Consumers must be treated fairly, and advertising is a key part of this.
  • Penalties are likely to be higher, particularly for repeated failures.

The ASA published a short guide to key CAP Code requirements for gambling adverts on 21 July, and guidance on the Gambling Commission requirements is also available on the Commission’s website. It’s not only the Gambling Commission and the ASA who are interested – the Information Commissioner’s Office is concerned to ensure that marketing by operators and their advertisers complies with privacy rules. A key area for concern is whether recipients of marketing material have given the necessary consent - and requirements for consent are going to get tighter when the EU General Data Protection Regulation comes into effect in May 2018.

It is also critical that advertising meets social responsibility obligations. Gambling adverts must not be sent to under 18s (under 16s for lottery adverts), or to anyone who has self-excluded. Targeting an advert may be critical to its compliance. In May, a Ladbrokes advert using an image of Iron Man and referring to the film Iron Man 3 was found not to be irresponsible because, although the Iron Man character was likely to appeal to under-18s, the offer was sent only to people who had been validated as being over 18.

The recent decisions and enforcement strategy make clear that affiliate breaches of advertising or privacy rules may result in an operator being fined and, potentially, even losing its gambling operating licence. Gambling operators, and their affiliates, are expected to learn from the experiences of others. Operators will want to prevent their affiliates putting them in breach, and a right to compensation for loss incurred if they do. Affiliates will similarly want to know that the operator’s marketing material will not cause the affiliate a problem. Both parties will need a mechanism for ensuring that marketing lists are checked against self-exclusion lists and other targeting criteria. 

Lessons learned from the ICO's annual report- It is all in the numbers

 

The ICO released its annual report recently, which includes figures on its enforcement activities during the previous year.  So what do the figures tell us? 

Unsolicited direct marketing has been a focus for the ICO for a number of years and last year the total fines issued for breaches of PECR (the law governing direct electronic marketing) surpassed total fines issued for breaches of data protection law.  The figures show that ICO enforcement resources are being used to try to change unsolicited marketing behaviours.  The ICO issued 23 fines for breaches of direct marketing law totalling £1,923,000 (compared with 16 fines totalling £1,624,500 for breaches of the data protection principles).  The key takeaways from this is to make sure you have records of valid marketing consents, document how you meet the soft opt-in criteria (where soft opt-in is being relied upon), listen to and respond quickly to any complaints and opt-out requests.

A draft ePrivacy Regulation governing direct marketing was published in January 2017 and the proposal is for the new law to apply from 25 May 2018 (the same time as the GDPR).  This timeline is looking increasingly impossible but businesses should be aware that changes to direct marketing law is in the pipeline, which is likely to involve the higher GDPR standards of consent for direct marketing and GDPR-level fines for non-compliance.

Although fines often grab headlines, the ICO has a number of other enforcement powers, which can result in significant costs, reputational damage and operational disruption when deployed against controllers.  Last year, 52 controllers signed undertakings committing their organisation to a particular course of action.  Undertakings are not a statutory regulatory power, but the ICO has been using undertakings alongside or instead of fines to improve compliance. Undertakings are usually signed by a senior person in an organisation and can include a commitment to undertake an audit and/or complete a data protection impact assessment.  There are often quite short deadlines for compliance with undertakings (typically one – three months) and the ICO follows up to check the undertaking has been adhered to.  The ICO has also been increasing its criminal enforcement (criminal cases resulting in prosecutions were up 50% in the last year).  The ICO secured 21 convictions, 6 of which were for not registering with the ICO.  This tells us that even though controllers will no longer need to register/notify with the ICO once the GDPR starts to apply, the ICO is still enforcing the law in this area (perhaps as an easy stick to use against non-compliant controllers).  

Sector focus: HealthTech deal activity in 2017 so far

Despite political and economic uncertainty in both the US and Europe, deal activity in the HealthTech sector remained relatively strong in the first quarter of 2017. According to HealthTech Heartbeat, a quarterly market update prepared by Results International, 51 M&A transactions were recorded in the quarter with a combined disclosed deal value of approximately $11.5 billion. This shows a slight dip when compared with the same period last year, which recorded 67 deals with a combined value of approximately $15 billion.  

Private fundraising activity in Q1 was also healthy. Beauhurst, an investment data platform containing information on UK fast-growth companies, shows 48 fundraisings in the medical technology space with a combined value of £159 million (compared with 26 fundraisings with a combined value of £75.4 million in the same period last year). Activity in Q2 remained buoyant: during this period Beauhurst shows £112.9 million raised by UK fast growth companies across 47 deals.

Key high-profile deals of the year so far include:

  • McKesson’s acquisition of CoverMyMeds for $1.1 billion (Jan 17) – McKesson, a US listed healthcare company, acquired CoverMyMeds, a provider of electronic prior authorisation solutions for prescription medications. The acquisition will increase McKesson’s technology offerings to doctors, pharmaceutical manufacturers and insurers. 
     
  • EQT Ventures and Octopus Ventures lead $10.5 million venture investment into MyTomorrows (Jan 17) – EQT Ventures and Octopus Ventures, alongside existing backers Balderton Capital and Sofinnova Partners, invested in the Netherlands based start-up which provides patients and doctors with information on, and access to, drugs which are in development or which have been approved by regulators in other countries.
     
  • Philips acquisition of a minority stake in Onelife Health in a low 7-digit Series A funding round (Feb 17) – Philips, a Dutch technology company listed in Amsterdam and New York, acquired a minority interest in German start-up Onelife Health. The partnership will initially focus on Onelife’s Femisphere App, which helps expectant mothers track key biological markers, behaviours and other variables throughout their pregnancy and identify potential risks or complications. The app automatically detects changes in data to provide feedback and advice. It also supports communication and information sharing between patients and medical professionals.
     
  • Cambridge Innovation Capital leads $10 million Series B investment into Congenica (Feb 17) – Existing investors Cambridge Innovation Capital and Amadeus Capital Partners invested alongside Parkwalk Advisors. Congenica is a leading provider of clinical genome analysis technology based in Cambridge, UK, which has developed the Sapientia technology platform. Sapientia enables clinicians and researchers to analyse genome-scale DNA data to facilitate clinical decision making and research.
     
  • Invest Northern Ireland, Innovate UK, Angel CoFund and Techstart NI invest $1.3 million in BrainWaveBank seed round (Mar 17) – BrainWaveBank, based in Northern Ireland, allows individuals to measure and track their cognitive health at home using a wireless headset. The platform uses machine learning and brain-reading technologies to build a record of cognitive health over time, providing insights and advice on how individual lifestyle factors affect performance.
     
  • Roche’s acquisition of Austrian diabetes platform MySugr for up to $100 million (Jul 17) – Roche, a Swiss listed healthcare company and existing investor, acquired mySugr, a digital diabetes management platform for up to $100 million. While the exact sales price was undisclosed, TechCrunch comment that this could well have been amongst the biggest HealthTech exits in Europe to date. MySugr helps diabetics track blood sugar, mediations and activity levels.

 

In addition, the main technology giants are becoming increasingly invested in HealthTech. Google’s subsidiary Verily (formerly Google Life Sciences), an entity focussed on life sciences and HealthTech, accepted an $800 million investment from Singaporean investment firm Temasek at the beginning of the year. Apple is reportedly working on turning the iPhone into a central bank for all medical information, increasing the potential for apps to be developed to use the data. Amazon’s Echo, a voice-activated computer that answers to the name Alexa, is continuing to accumulate healthcare skills (including being able to recite instructions on how to resuscitate someone having a heart attack). As the shift to digital continues, it feels as if the disruption of the health care sector by technology is only just beginning. It’s clear that HealthTech is an exciting sector to watch as the year continues.

The Fourth Money Laundering Directive, Scottish Partnerships and People with Significant Control

  • UK Implementation of the Fourth Money Laundering Directive

The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the “Regulation”) came in to force on 26 June 2017, replacing the 2007 regulations. The Regulation requires “relevant persons” (i.e. firms to which the Regulation applies (e.g. credit institutions, financial institutions, legal professionals, estate agents, high value dealers, etc.)) to ensure that measures they take in meeting customer due diligence and ongoing monitoring obligations are based on an overall assessment of the money laundering/terrorist financing risks that such relevant person faces. This includes taking account of guidelines published by the European supervisory authorities, UK supervisory authorities and the UK Government’s national risk assessment.

The main changes to the existing anti-money laundering processes are as follows:

  • relevant persons are required to carry out risk assessments and maintain adequate procedures to mitigate money-laundering risks;
  • the focus on risk-based procedures means that the mandatory customer due diligence process will now vary between different customer types:
    • - simplified due diligence may be warranted in low-risk cases which take into account types of customers, geographic areas, and particular products, services, transactions or delivery channels;
    • - a relevant person is obliged to run enhanced due diligence in certain situations, such as, amongst others, the establishment of a business relationship or transaction with a person in a high-risk third country or if a relevant person has determined that a customer or potential customer is a “politically exposed person”;
  • relevant persons are required to identify any beneficial owner who is not their customer and take adequate measures, on a risk-sensitive basis, to verify their identity. That includes measures to understand the ownership and control structure of a company, trust or similar arrangement; and
  • trustees which are UK resident or, if not UK resident, are liable to pay UK tax will be required to maintain a register of beneficial owners in relation to the trusts which they administer and report to HMRC on the same.

Scottish Partnerships and People with Significant Control

On 26 June 2017, The Scottish Partnerships (Register of People with Significant Control) Regulations 2017 came into force. This ensures that a general partnership constituted under the law of Scotland that is a qualifying partnership under regulation 3 of the Partnership (Acccounts) Regulations 2008 (i.e. a limited partnership with solely corporate partners) (an “SQP”) will be required to deliver people with significant control (“PSC”) information to Companies House.

This means that all SQPs will be required to investigate their ownership and control structure. From 24 July 2017, all SQPs will need to file an annual confirmation statement at Companies House that sets out, amongst other things, its PSCs.

The new legislation may affect SQP’s desirability as investment vehicles, especially in private equity and property investment fund structures as the traditional advantages of SQPs – such as separate legal personality and tax transparency – will need to be weighed against the public disclosure of those individuals who hold a controlling interest, directly or indirectly, in the SQP.

An SQP can have more than one PSC. A PSC is a person who:

  1. directly or indirectly holds the right to more than 25% of the surplus assets on winding up of the SQP;
  2. directly or indirectly holds more than 25% of the voting rights in the SQP;
  3. directly or indirectly holds the right to appoint or remove the majority of those entitled to take part in the management of the SQP;
  4. otherwise has the right to exercise, or actually exercises, significant influence or control over the SQP;
  5. has the right to exercise, or actually exercises, significant influence or control over the activities of a trust and the trustees of the trust hold, directly or indirectly, any of the rights set out in a) to d) above; and/or
  6. has the right to exercise, or actually exercises, significant influence or control over the activities of a firm and the members of the firm hold, directly or indirectly, any of the rights set out in a) to d) above.

Share options: limits on the exercise of discretion

In the case of Watson & Ors v Watchfinder.co.uk Ltd, the High Court considered a provision in an option agreement which purported to give the board complete discretion over whether an option could be exercised.

Case background

The claimants were three individuals who owned a business development consultancy engaged by Watchfinder to provide various services. They were paid a monthly retainer for their services and separately entered into an option agreement to purchase a particular percentage of Watchfinder’s shares at a given price. The option agreement provided that ‘the option may only be exercised with the consent of a majority of the board of directors [of Watchfinder]’.

The claimants tried to exercise the option but the board of directors refused consent. The claimants brought a claim for specific performance of the option agreement, arguing that Watchfinder could not exercise its discretion over the grant of consent in a way that was arbitrary, capricious or irrational.

The Court’s decision

The High Court concluded that the clause could not be interpreted as giving Watchfinder an unconditional right of veto of exercise of the options as this would render the option worthless as the grant of shares would be entirely within the gift of Watchfinder and the position would be no different from when any person sought to buy shares in Watchfinder. It therefore found it was a discretionary power which was subject to implied limits. The judge held that there was a duty on the board to follow a proper process, including taking into account the material points and not taking into account irrelevant considerations and to not reach an outcome which was outside what any reasonable decision-maker could decide.

In this case, there had not been any proper exercise of the discretion; there had been no real discussion at the board meeting and the board had reached an arbitrary decision, the Court therefore held that it should proceed as if consent had been given and the claimants were accordingly granted specific performance of the option agreement.

Practical implications

  • Don’t rely on an absolute veto right in an option agreement - if a company wishes an option to only be exercisable in certain circumstances, it should introduce conditions into an option agreement.
     
  • When exercising discretion - ensure that a proper process is adopted. The board should act reasonably and give proper weighting to the material facts.
     
  • Produce a document trail – keep accurate board minutes when the board is exercising discretion under share plan rules.

Limitation periods for breach of fiduciary duties

It is common understanding that claims arising out of obligations pursuant to contracts and most statutes are subject to section 8 of the Limitation Act 1980 (LA 1980) and such claims cannot not be brought after expiration of six years from the date on which the right of action accrued, unless they fell within certain exemptions set out in specific statutes.

In the case of directors’ duties, the limitation periods will depend upon whether the duties that have been breached are equitable or tortious duties, whether there was an allegation of fraud and the remedies sought.  This short note discusses the recent case of First Subsea Ltd v Balltec Ltd and others [2017] EWCA Civ 186 and its effect on the availability of the limitation period defence to directors who fraudulently breach their fiduciary duty.

Trustee relationship

A director of the company owes a fiduciary duty towards the company. Companies Act 2006 codifies certain of those duties. This fiduciary relationship gives rise to a relationship of trust and confidence.  In the case of Paragon Finance plc v DB Thakerar & Co [1999] 1 All ER 400, the court made a clear distinction between two categories of constructive trustees:

  • “class 1 trustees” including real trustees who receive trust property by a transaction where both parties intended to create a trust; and
  • “class 2 trustees” where the defendant is implicated in fraud and is therefore liable to account as a constructive trustee by virtue of fraud.

Directors, by virtue of owing fiduciary duties, are classified as class 1 trustees.

Section 21 of LA 1980

According to section 21(3) of LA 1980, subject to other provisions of section 21, an action by a beneficiary to recover trust property or in respect of any breach of trust shall not be brought after the expiration of six years from the date on which the right of action accrued.  But, section 21(1) of LA 1980 sets out certain exemptions on the application of section 21(3) of LA 1980.

Section 21(1)(b) of the LA 1980 provides that no period of limitation shall apply to an action by a beneficiary under a trust being an action to recover from the trustee trust property or the proceeds of trust property in the possession of the trustee, or previously received by the trustee and converted to his use. Accordingly, a director who misappropriated company’s property or disposed of company’s property in breach of his fiduciary duties would not be able to rely on the limitation period defence.

Further, section 21(1)(a) provides that no period of limitation shall apply to an action by a beneficiary under a trust being an action to in respect of any fraud or fraudulent breach of trust to which the trustee was a party or privy.  Class 2 trustees would be caught by section 21(1)(a).  However, it was unclear as to whether section 21(1)(a) was engaged in the case of a class 1 trustee who commits fraud that does not involve misappropriation of property.  Did section 21(1)(a) only apply to class 2 trustees?

First Subsea

Recently, in March 2017, in the case of First Subsea the Court of Appeal unanimously held that section 21(1)(a) was engaged in cases where a class 1 trustee committed fraud and the breach did not involve misappropriation of property.

The case involved a director, Mr Emmett, of First Subsea who had breached his fiduciary duties to the company. Mr Emmett set up a rival company, Balltec Limited, to bid for a contract in competition with First Subsea. This was clearly in breach of Mr Emmett’s fiduciary duties owed to First Subsea. There was no misappropriation of property. Therefore, section 21(1)(b) of LA 1980 was not engaged. As this was not a case of constructive trust (i.e. not a class 2 trustee), the defendant argued that section 21(1)(a) was not engaged. However, Patten LJ reasoned as follows: “A director cannot be a class 1 fiduciary for the purposes of LA 1980 section 21(3) but not for the purposes of section 21(1) and for the same reason I do not see how it is possible to treat a director differently as between section 21(1)(a) and section 21(1)(b)”. It was therefore held that, as the director was involved in fraudulent breach of his fiduciary duties, section 21(1)(a) was engaged and that he could not rely on the limitation period defence.

In conclusion, there is now clear case law setting out that directors of a company who fraudulently breach their fiduciary duty will be unable to rely on the limitation period defence even though no misappropriation of company’s property is involved.

Sutton V Rydon: Literal V commercial common sense

The recent judgment in the case of Sutton Housing Partnership Limited v Rydon Maintenance Limited [2017] EWCA Civ 359 showed that there will be times when commercial common sense should override the literal meaning when it comes to contract interpretation.

Background

In May 2013 Sutton Housing Partnership (“Sutton”), who manage the housing stock of the London Borough of Sutton, entered into a contract with Rydon Maintenance Limited (“Rydon”), a contractor which specialises in the maintenance and repair of housing, where Rydon would maintain and repair Sutton’s Housing stock (“the Contract”). The Contract permitted Sutton to give notice of termination to Rydon should certain minimum acceptable performance levels (“MAPs”) not be met. Incentives for Rydon were also provided in the Contract where Rydon would be entitled to further payments from Sutton should the MAPs be exceeded.

On 12 November 2014, Sutton served notice to Rydon asserting that they had failed to achieve the contractual MAPs and consequently terminated the Contract in December 2014. Rydon argued that this termination was invalid as the MAPs were merely examples as opposed to being contractually binding.

During the subsequent adjudication, the adjudicator decided that the MAPs were in fact purely illustrative and awarded damages in favour of Rydon for wrongful termination. Sutton appealed this decision and the case went to the Court of Appeal. 

Judgement

The Court of Appeal overturned the judgement and held that the MAPs were contractually binding. Applying Arnold v Britton [2015] UKSC 36, the judge, Mr Justice Jackson, stated that by having termination provisions for Sutton’s benefit and by having incentivisation clauses in favour of Rydon, then the parties must have intended for the Contract to specify MAPs or otherwise these clauses would be inoperable. His reasoning was that commercial common sense needed to prevail as any reasonable person acting for either side would have also intended for the MAPs to be specified in the Contract. He also rejected Rydon’s argument that even if the MAPs were binding, then this should only be for the years stated in the example (2014-2015) as it would be “absurd” in allowing Sutton to terminate and Rydon to claim bonuses in just the first year but not thereafter. Jackson LJ stated that this view was “the only rational interpretation of the curious contractual provisions into which the parties have entered”.

Conclusion                                                                                                                                                                     

Although this case did not set a precedent for a new law, Jackson LJ’s reasoning in his judgment is well worth reading as he suggests that where a contract is unclear, common sense will prevail in interpreting it.

This case showed that in interpreting contracts, there needs to be a balance between taking a literal approach and applying simple commercial sense. Taken literally, the Contract would have contained no MAPs but the whole of Jackson LJ’s reasoning was based on the premise that there needs to be some degree of common sense that needs to be applied in order to prevent any absurd results.  

Therefore, we need to ensure two main factors are considered when dealing with potentially unclear contracts:

  • whether either parties’ interpretation of the contract produce absurd results; and
  • whether either of these interpretations would deprive a party of a valuable benefit that they would not have reasonably wanted to give up.

Ultimately, his reasoning reinforces Arnold v Britton where Lord Neuberger emphasised certain factors that should be considered when interpreting a contract. These included:

  • the natural and ordinary meaning of the clauses (the worse the drafting, the more readily the courts can depart from their natural meaning);
  • any other provisions of the contract that would provide more clarity to the meaning of the unclear clause;
  • the overall purpose of the clause and the contract;
  • the facts and circumstances which existed at the time that the contract was made and which were known or reasonably available to both parties; and
  • applying simple “commercial sense”.

There is a lot of guidance at present derived from a range of case law on how to interpret unclear contracts and Jackson LJ himself said “lawyers are now lucky enough to live in a world overflowing with appellate guidance on how to construe contracts.” but this case is a good reminder that sometimes we can just apply a bit of common sense.

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