Corporate Law Update: 9 - 15 July 2022

15 July 2022

In this weeks update: The UK’s new register of overseas entities is to launch on 1 August 2022, a one-year non-compete covenant in a franchise arrangement was unenforceable, the FRC publishes a position paper setting out steps towards its transition to the new ARGA and the LSE extends its consultation on changes to its Admission and Disclosure Standards and the new Voluntary Carbon Market and consults on expanding Stock Connect.

Register of overseas entities to go live on 1 August 2022

Companies House has published a blog confirming that the new register of overseas entities that hold registrable real estate in the United Kingdom should go live on Monday, 1 August 2022.

What is happening?

In the blog, Companies House states that the Government expects the commencement order to be laid in Parliament on 1 August 2022 and the register to come into effect on the same date.

Under the regime, an overseas entity that holds or wishes to acquire certain types of real estate in the UK will need to register with Companies House and provide details of its “beneficial owners” and (in some cases) managing officers and any trusts that sit within its corporate structure.

From 1 February 2023, an overseas entity that already holds this type of real estate in the UK and was registered as the proprietor on or after 1 January 1999 will not be able to dispose of, lease out or charge that real estate unless it registers under the new regime and obtains a registration number. Likewise, an overseas entity that wishes to acquire this type of real estate will not be able to do so without registering and obtaining a registration number.

For more information, see our previous Corporate Law Update.

Under recent legislation (on which we reported last week), an overseas entity will not be able to apply for registration and obtain a registration number unless a “relevant person” first verifies the information on the entity, its beneficial owners and (if applicable) its managing officers and any registrable superior trusts, and confirms to Companies House that it has done so.

For these purposes, a “relevant person” includes (broadly speaking) credit and financial institutions, auditors, insolvency practitioners, external accountants, tax advisers, independent legal professionals, trust and company service providers, estate agents and letting agents.

Before a “relevant person” can verify information on an overseas entity, it will itself need to register with Companies House and obtain its own registration number.

What does this mean for me?

Assuming all aspects of the regime come into force at the same time, this has the potential to disrupt the timetable for any ongoing acquisitions of land by overseas entities. An acquisition will not be able to complete on or after 1 August 2022 unless the overseas entity has registered under the new regime.

However, in practice, it may well be difficult or impossible to complete on or shortly after 1 August 2022. This is because:

  • the acquiring overseas entity will need to identify a “relevant person” to verify its information;
  • that “relevant person” will need to carry out the verification checks, which, depending on the ownership structure of the overseas entity, could take some time and could require substantial amounts of documentation;
  • the “relevant person” will need to register with Companies House, which might not even be possible before 1 August 2022, and then wait to be issued a registration number; and
  • the overseas entity will then need to apply for registration and the “relevant person” will need to give a confirmation of verification to Companies House, which, again, cannot happen before 1 August 2022 or before the “relevant person” has received its own registration number.

This situation is exacerbated by the fact that the draft Regulations published in June 2022, which would alter the beneficial ownership analysis for some overseas entities (see our previous Corporate Law Update), have not yet become law (although we expect them to be approved next week).

As a result, overseas entities that are looking or committed to acquire registrable UK real estate should take the following steps.

  • Establish what information needs to be provided to the register. This will involve conducting or commissioning a legal analysis of the entity’s ownership structure and assembling the relevant information. Entities should, at this stage, proceed on the basis that the draft Regulations described above will become law as they stand.
  • Identify someone to verify the information. Overseas entities should bear in mind that verification may not be straightforward. Some information to be provided to Companies House may be difficult or, in practice, impossible to verify to a standard which a relevant person can stand behind. It is natural that relevant persons may feel unable to verify information in the absence of further guidance from the Government on what is expected of them.
  • Assess the transaction timetable. Although many transactions will already have factored the new regime into account, not all will. If it is not possible to complete the acquisition before 1 August 2022, the parties should discuss sensibly what adjustments need to be made to the proposed completion date to accommodate the new regime coming into force.

Overseas entities that already hold registrable UK real estate will have until 1 February 2023 to register under the regime. Once the transitional period begins on 1 August 2022, HM Land Registry will begin placing restrictions on title registers preventing overseas entities from disposing of, leasing out or charging the property, although those restrictions will not take effect until 1 February 2023.

If they have not already begun doing so, these overseas entities should now start analysing their ownership structure and gathering the information they will need to submit to Companies House.

One-year non-compete restriction was unenforceable

The Court of Appeal has held that a non-compete covenant in a ten-year franchise agreement was unreasonable and, therefore, not enforceable.

What happened?

Dwyer (UK Franchising) Ltd v Fredbar Ltd and another [2022] EWCA Civ 889 concerned a franchise arrangement under which Dwyer, a large US-based home services provider, licensed Fredbar to use its branding and trade name to provide home drainage services in parts of Cardiff.

Fredbar was established and owned by a Mr Bartlett, who had left his existing employment and sole source of income to pursue the franchise and had committed his available assets to that new business.

Dwyer and Fredbar entered into the franchise agreement for a period of ten years. However, the first year of trading was not nearly as profitable as Dwyer had projected. In the second year, Mr Bartlett entered a three-month period of self-isolation under UK Government Covid-19 guidance, causing the franchise to come to a halt.

A dispute then arose over whether there had been a breach of contract, with both parties ultimately purporting to terminate the franchise agreement.

At around the same time as Fredbar purported to terminate the franchise, Mr Bartlett began operating a competing business both within the franchise territory and elsewhere.

The franchise agreement stated that, for a period of one year after the franchise ended, Fredbar would not (directly or indirectly) “be engaged concerned or interested in a business similar to or competitive with” the franchise business within the franchise territory or a radius of five miles of that territory. This amounted to a non-compete clause, a type of restrictive covenant or restraint of trade.

Under English law, a restrictive covenant will be unenforceable unless it is reasonable by reference to the legitimate interests of the parties concerned and the interests of the public. When deciding whether a covenant is reasonable, a court will look at various factors, including what the covenant is looking to achieve, its duration and breadth, the parties’ bargaining power and whether the restriction impacts the public. However, the court is not limited in the factors it can take into account.

Dwyer applied to the court for an injunction to prevent Mr Bartlett from conducting the competing business. The High Court refused to grant the injunction, concluding that the non-compete covenant in the franchise agreement was unreasonable for eleven reasons. Dwyer appealed the decision.

What did the Court of Appeal say?

The court affirmed the decision of the High Court and found that the non-compete covenant was unreasonable and, therefore, unenforceable.

One point over which the parties had argued was whether the franchise agreement was more like an employment contract (where restrictive covenants are typically viewed more critically and harder to enforce) or the sale of a business with goodwill (where the courts take a more relaxed approach).

But the court made it clear that this binary distinction is artificial and a restrictive covenant does not simply fall into one category or another. The concept of restraint of trade is not confined to rigid categories with no clear limits. Indeed, the court noted that franchise agreements themselves do not form a special category to which the same principles will always apply.

Rather, the court will consider each restrictive covenant in its particular context and consider various factors when deciding whether the covenant is reasonable (see “What does this mean for me?” below).

In this case, Dwyer had significantly more bargaining power than Mr Bartlett. It knew that Fredbar and Mr Bartlett were starting up a business with a sole employee who had no plumbing experience. The failure of the franchise was foreseeable, and Dwyer knew that Mr Bartlett was investing all his savings and would be at serious risk of losing the family home if the franchise did not succeed. There was no evidence the parties had discussed or negotiated the non-compete covenant to take account of this.

What is more, the non-compete covenant did not reflect the fact that the goodwill Dwyer was seeking to protect would accumulate over the life of the franchise. That goodwill would be less extensive and less valuable if the franchise terminated early on than if it terminated having operated successfully for several years. The covenant treated both scenarios identically, which made it unreasonable.

What does this mean for me?

Non-compete clauses, non-solicitation clauses and other kinds of restrictive covenant are seen very frequently but, as this case shows, can be very fragile. It is always useful to receive more commentary on the factors the courts will take into account when deciding whether a covenant is enforceable.

Although this case concerned a franchise arrangement, the principles the court deployed – particularly its comments on an anticipated increase in goodwill over time – can be applied to other scenarios.

Most obviously, this includes the sale of a nascent business where the sellers remain involved in some way (for example, as directors or senior employees) or an investment in a start-up (where covenants given by a founder may run for the lifetime of the investment as well as after an exit or the relevant founder’s departure).

The courts have traditionally viewed franchises as being nearer to a business sale than an employment relationship, routinely upholding one- and two-year restrictions. This case is, therefore, a good example of how the courts will not hold rigidly to the traditional distinction between the two.

A court will assess the reasonableness of a restrictive covenant by reference to the circumstances that existed when the parties signed the contract. To maximise enforceability, therefore, a person looking to extract the benefit of a restrictive covenant should ask several questions at the time of negotiating the covenant and the contract as a whole.

  • What is the person giving the covenant getting in return? The greater the reward for the person giving the covenant, the more likely it is the courts will find that there is justification for restraining that person’s activities.
  • Are the parties of equal bargaining strength? If the person giving the covenant has substantially less bargaining power than the person seeking it, the courts may be more inclined to find that it is unreasonable. In this case, the person seeking the covenant could consider paring it back or suggesting to the other party that they seek legal advice on the covenant.
  • Does the covenant apply during or after the contract? The courts are more prepared to uphold a restrictive covenant that applies during the lifetime of a contractual relationship, as there is a clear interest to protect. If the covenant is to continue after, or even to start from, the point at which the contract ends, the person seeking the covenant will need to consider further matters below.
  • How long will the covenant last? Generally speaking, the longer the covenant, the harder it will be to enforce. There is no fixed duration beyond which a covenant becomes unreasonable. But there should be some logic tying the duration of the covenant to the interest being protected.
  • How wide should the covenant be? Most non-competes cover a specific geographical area. The starting point is normally the area covered by the business to be protected. It may be legitimate to widen that area, particularly where a business is still in its start-up or growth phase and its target market remains a projection, but too wide an area and the covenant will be unenforceable.
  • Does the covenant cater for different circumstances? As a general rule, a non-compete covenant should be designed to protect goodwill. There may be little or no goodwill at the start of a relationship or investment, but an expectation that goodwill will build up over time. Any non-compete covenant should recognise this.

FRC publishes position paper on transition to ARGA

The Financial Reporting Council (FRC) has published a position paper setting out how it intends to support the Government in the transition from the FRC to the new Audit, Reporting and Governance Authority (ARGA).

The FRC has set out five areas on which it intends to focus.

  • Revising and adding to existing codes, standards and guidance to implement the reforms. This will include a revised UK Corporate Governance Code (to apply for financial years beginning on or after 1 January 2024) and changes to the FRC’s existing Guidance on Audit Committees, on Board Effectiveness and on Risk Management, Internal Control and Related Financial and Business Reporting. It will not extend to the FRC’s Stewardship Code.
  • Developing new standards in “shadow form” which organisations can adopt on a voluntary basis in anticipation of legislation in due course. The paper gives “Minimum Standards for Audit Committees” as an example.
  • Setting expectations for the markets the FRC regulates so as to drive behavioural changes ahead of ARGA using its new statutory powers.
  • Developing guidance to address issues set out in the Government’s response to its consultation on audit and corporate governance reform, whilst remaining conscious of the recommendation that ARGA should be sparing when issuing guidance and focus on those areas where it has expertise.
  • Setting high-level expectations around the future supervision and monitoring activities that will flow from the proposed revisions to existing codes, standards and guidance.

LSE extends consultation on Admission Standards and VCM and consults on expanding Stock Connect

In May 2022, the London Stock Exchange announced (in Market Notice N12/22) that it was consulting on changes to its Admission and Disclosure Standards (the Standards) and on the creation of a new Voluntary Carbon Market (VCM). The consultation was originally due to close on 11 July 2022.

For more information on that consultation, see our previous Corporate Law Update.

The Exchange has now announced (in Market Notice N14/22) that it has extended the deadline for responding to the consultation to 1 August 2022. This is to enable the Exchange to:

  • pose further questions on the proposed launch of the VCM designation; and
  • make changes to the Standards in respect of the Shanghai-London Stock Connect (which allows issuers on the Shanghai Stock Exchange (SSE) Main Board to list their securities in the UK using global depositary receipts) following rule changes by the China Securities Regulatory Commission.

In relation to the VCM, the Exchange has asked for views on extending the new market beyond funds to include other issuers (specifically, operating companies on its Main Market or on AIM) from the outset, rather than (as originally proposed) at a later stage following launch.

In relation to Stock Connect, the Exchange is proposing to expand the service to issuers on the SSE Science and Technology Board, the Shenzhen Stock Exchange (SZSE) Main Board and the SZSE ChiNext Market. It is also proposing to remove the minimum market capitalisation criteria for SSE and SZSE issuers.