Financial Services & Markets Dispute Resolution Quarterly Bulletin: October 2017 Edition
In this edition, we discuss in detail the new corporate offence of failure to prevent the facilitation of tax evasion under the Criminal Finances Act 2017.
Recent developments in case law include three recent decisions on the exercise of a contractual discretion, which so often underlies the closing out of a defaulting party’s positions, and the Court of Appeal’s ruling on a bank’s duty of care in regard to past business reviews.
- New corporate offence of failure to prevent the facilitation of tax evasion
- Investigations and use of compelled testimony overseas
- Senior Managers and Certification Regime: Extension to all firms
- The future of LIBOR
- Recent judgments
The UK Criminal Finances Act 2017 came into force on 30 September 2017, and includes the new corporate offences of failure to prevent the facilitation of UK and foreign tax evasion. The new regime permits corporates and partnerships (which includes any body or partnership, whether or not it is commercially motivated) to be found criminally liable for failure to prevent the facilitation of tax evasion committed by their employees, agents and anyone else associated with the relevant body, even in cases where senior management were not involved nor had any awareness of the relevant misconduct.
An offence will be committed by a corporate if: (i) a person who provides services for or on behalf of the corporate criminally facilitates tax evasion by another person; and (ii) the corporate did not have reasonable procedures in place to prevent such facilitation. Under the new regime, all corporates will therefore need to take positive steps to engage with the different methods of facilitating tax evasion within their business and introduce reasonable prevention procedures to minimise these risks.
The sanctions include unlimited financial penalties and confiscation orders as well as other ancillary orders. Potentially more damaging will be the serious reputational impact and any consequential loss of regulatory approval and consents if a corporate were to be found liable.
An article published by the Macfarlanes Tax Investigations and Disputes team explains (i) the breadth of the new regime, (ii) the steps that corporates and partnerships will need to take to ensure compliance, and (iii) the consequences of non-compliance.
To access this article, click here.
In United States of America v Allen 16-898-cr (L), the United States Court of Appeals for the Second Circuit quashed the initial US convictions of two British bankers (A and C) found to have been involved in the manipulation of LIBOR on the grounds that the convictions were secured using compelled testimony given in the UK, in contravention of the US Fifth Amendment.
In October 2013, the UK FCA launched an investigation into both A and C, who were subject to compelled interviews. Whilst the FCA offers direct use immunity in respect of compelled testimony (i.e. the testimony itself cannot be used to secure a conviction), it does not offer derivative immunity (i.e. the testimony can be used to provoke new information which could be used to secure a conviction). Subsequently, the FCA initiated proceedings against a colleague of the Defendants, R, only for this to be stayed and picked up by the US Department of Justice (US DOJ).
R pleaded guilty and then acted as a key witness in the US criminal trial which saw A and C convicted. In overturning these convictions, the US Court of Appeals found that the Fifth Amendment requires that any person compelled to give testimony is granted both direct use and derivative immunity. In Allen, the US DOJ failed to show that R’s evidence had not been tainted by (and therefore was not derived from) the compelled testimony of the Defendants (R had been permitted to review and keep copies of the testimony which A and C had given to the FCA).
US and UK regulators will now need to work closely at the outset of any joint interest investigation in order to ensure that one regulator’s investigation is not prejudiced by the actions of the other regulator. Individuals are likely to take some comfort from the fact that their compelled testimonies in the UK cannot be used against them in the US. Where an investigation in the US is a real prospect, those being investigated in the UK should now think even more carefully than before about whether they should give evidence voluntarily or wait until they are compelled to do so.
At the end of July, the FCA published a consultation paper (CP17/25) on extending the Senior Managers and Certification Regime (SM&CR) to almost all financial services firms.
The FCA states that the new regime should be “proportionate and flexible enough to accommodate the different business models and governance structures of firms”. The proposals therefore focus on tailoring the existing regime (which only applies to banks, building societies, credit unions and PRA-designated investment firms) to reflect the different risks, impact and complexity of firms falling within the scope of the extended regime.
The FCA proposes a three-tier model for the extended regime:
- Core Regime: involving an application of a baseline of requirements to all firms that it regulates, which are not currently subject to the SM&CR (referred to by the FCA as solo-regulated firms). The three main elements of the core regime are: the Senior Managers Regime, the Certification Regime and the Conduct Rules.
- Enhanced Regime: applicable to a small number of solo-regulated firms whose size, complexity and potential impact on consumers warrant extra requirements.
- Limited Scope Regime: applicable to firms who are currently subject to a limited application of the Approved Persons Regime (for example, limited permission consumer credit firms and sole traders). These firms will be subject to a reduced set of requirements.
The deadline for submitting comments on CP17/25 is 3 November 2017 and it is expected that the new regime will come into force next year.
Click here to read our more detailed note on the FCA’s proposals.
Andrew Bailey (Chief Executive of the FCA, AB) delivered a speech on 27 July 2017, in which he examined a number of important questions about the future of LIBOR.
He noted that while significant improvements have been made to the benchmark since 2013, the absence of underlying markets raises a serious question about the sustainability of LIBOR. It is therefore the FCA’s intention that LIBOR will be phased out by the end of 2021. The FCA has been liaising with the panel banks in relation to this proposal, and there has been wide support for sustaining LIBOR over this period.
In terms of what might replace LIBOR, Andrew Bailey emphasised that any alternative reference rates must be “based firmly on transactions”. The Risk Free Rate Working Group in the UK has selected SONIA as its proposed benchmark after LIBOR.
Of fundamental importance will be the legacy contracts that still reference LIBOR in 2021. The options are either to amend contracts to reference an alternative benchmark, or to amend the definition of LIBOR to refer to an alternative reference rate. These options will need to be considered carefully as the transition progresses, and contractual documentation will need to be reviewed and amended as appropriate.
There have been three recent cases in which the Court has considered the circumstances and manner in which a party may exercise a contractual discretion.
Exercise of veto in share option agreement
In Watson and others v Watchfinder.co.uk Ltd  EWHC 1275 (Comm), it was held that where a share option agreement provided that the option could be exercised only with board consent, this effective right of veto was discretionary, rather than an unconditional right, such that the discretion could not be exercised capriciously, arbitrarily or unreasonably.
The Claimants were directors and shareholders of a business development consultancy, retained by the Defendant (W) to assist W in attracting investors. W also entered into a share option agreement with the Claimants under which the Claimants could purchase a certain percentage of W’s issued share capital at a specific price. Clause 3.1 stipulated that the option could not be exercised without the consent of a majority of the W’s board. The Claimants later sought to exercise the option, but W’s board refused to give consent. As a result, the Claimants brought proceedings for specific performance of the share option agreement, arguing that as a matter of construction of the agreement, or by way of an implied term, W could not exercise its discretion in relation to the grant of consent in a way that was arbitrary, capricious or irrational (see Socimer International Bank Ltd v Standard Bank  EWCA Civ 116).
It is well-established that whether as a matter of construction or the implication of a term, the Court may find a contractual discretion is to be exercised in a way that is not arbitrary, capricious or irrational in the public law (Wednesbury) sense. Whilst this is not inevitable in every case, the Court found that it clearly should be so here. Therefore, the Court ordered specific performance of the agreement despite the lack of board consent.
Collection fees: The Peril of not Exercising a Contractual Discretion
In BHL v Leumi ABL Limited  EWHC 1871 (QB), a clause in a Receivables Finance Agreement (Schedule 6, paragraph 2) permitted the Defendant (L) to charge a collection fee of “up to 15%” of amounts collected by it in certain circumstances, in respect of unpaid invoices. It was also agreed by L’s client (Cobra Beer Limited, in which the Claimant was a shareholder), that “such fee constitutes a fair and reasonable pre-estimate of [L]’s likely costs and expenses in providing such [collection] service to the Client.” L duly collected approximately £8,000,000, and charged a 15% fee of approximately £1.2 million plus VAT.
One of the principal issues for the Court was whether L had a discretion to charge a fee based on estimated or actual costs, but which could go no higher than 15%, and if so, whether L had exercised its discretion properly or at all in calculating the fee.
The Court rejected L’s argument that it had made a sensible pre-estimate of its costs of collection, and found that L had charged the maximum 15% (in the scale of ‘up to 15%’) without any proper exercise of a discretion. Even on a conservative approach, in favour of L, it was held that L could not have rationally charged a fee of more than 4% of the total collections.
This case is yet another recent example of the fetter placed upon a contractual discretion, which must be exercised in good faith and reasonably, in the public law (Wednesbury) sense, and not arbitrarily or capriciously.
Broker has absolute rights and not just a contractual discretion
In Shurbanova v Forex Capital Markets Limited  EWHC 2133, the Court considered the nature of the contractual rights (under Terms of Business) of an online foreign exchange and commodities broker where the broker considered that a client was trading gold and US Dollar CFDs “abusively”, in breach of their agreement. In particular, the Court considered whether the broker had a discretion to act, which would have to be exercised rationally (see Socimer International Bank v Standard Bank (above) and Braganza v BP Shipping  1 WLR 1661), or whether the broker simply had absolute contractual rights such that the exercise of them could not be challenged.
The Court found that the broker had a bare contractual right to revoke the abusive trades, adjust the client’s account and treat the trading as an “event of default” giving rise to various remedies. However, these options did not give the broker an implied duty of good faith, with a discretion of the Socimer/Braganza kind; that is concerned with a determination of a substantive matter or a judgement about, or evaluation of, some state of affairs which one party makes as a decision maker, but which affects the interests of both, hence giving rise to a potential conflict of interest. It was relevant that the contract did not reserve the right for the broker to determine finally whether there had actually been abusive trading.
If the broker’s powers in respect of abusive trading were to be treated as a matter of discretion of the relevant kind, then any party’s choice as to whether or not to rescind a contract for misrepresentation, as opposed to seeking damages, would be a contractual discretion subject always to the Socimer/Braganza duty to act rationally etc, which could not be right.
Other recent Judgments
No duty of care for banks when conducting past business reviews of Interest Rate Hedging Products
In the case of CGL Group v Royal Bank of Scotland  EWCA Civ 1073, appeals were joined, concerning the past business reviews (“PBRs”) of the sale of Interest Rate Hedging Products (“IRHPs”) by three banks (the “Banks”).
The Court of Appeal found that the Banks did not owe a duty of care when conducting the (voluntary) PBRs. The Claimants (who participated in the PBRs) were not offered redress by the Banks, and alleged that the Banks had failed to conduct the PBRs in accordance with the undertakings they had provided to the FCA, or with the agreed methodology, and that the PBRs had been conducted negligently. The Claimants concluded that if the Banks had conducted the PBRs properly, redress would have been offered.
The Court of Appeal decided that it would not be fair, just or reasonable to impose a duty of care in the circumstances of an FCA-mandated process:
- The PBR agreements were between the Banks and the FCA. Where there is a failure to follow the terms of these agreements, it is for the FCA to bring enforcement proceedings against the Banks. To impose a common law duty on a statutory regulatory framework would be unusual where the effect of the statutory regime is that a non-private customer cannot sue in relation to a complaint or a complaint handling issue, or a redress determination, if a bank proactively sets up a redress scheme.
- Correspondence sent to the claimants which indicated that the banks would conduct a thorough review did not equate to an assumption of responsibility between the bank and the customer. The PBRs were mandated by the FCA, and to impose a duty would be to say that the banks assumed a duty to do what they had agreed with the FCA.
- Appointment of a Skilled Person pursuant to s166 (FSMA) was a further indicator against imposing a duty of care. In circumstances where the Skilled Person did not owe a duty of care to a customer in reviewing a decision made by the relevant bank, it would be odd for that bank to owe a duty when reaching its initial decision.
- The claims were otherwise time-barred. To impose a duty of care would circumvent an applicable limitation period.
Permission to appeal applications have been lodged by all Claimants before the Supreme Court.
Court reaffirms ‘no real prospect of success’ test for summary judgment
In Andric v Credit Suisse and another  EWHC 1724, the Claimant alleged that an employee of the Defendant Bank had induced the Claimant into paying a €8.25m deposit to help finance the purchase of a property in Canary Wharf.
The property transaction fell through, and the Claimant lost his deposit. The Claimant argued that the Bank was liable for the cost of the deposit by virtue of a £150m guarantee it had provided him in relation to his financing of the property development.
The Bank argued, inter alia, that (i) there was no evidence that the deposit was paid; (ii) the relevant bank employee had no authority to provide a guarantee on its behalf; and (iii) there was no written evidence of the guarantee agreement. Therefore, the claim was doomed to fail.
The Court, whilst recognising that the Claimant’s claim faced undoubted difficulties and was likely to fail, held that this was not enough for the application for summary judgment to succeed. Summary judgment is not granted because a claim will probably fail. What must be shown is that the claim has no real prospect of success.
In order for the claim to have no real prospect of success, it had to be shown on the facts that the prospects of success were no more than fanciful. This was a high hurdle to reach at the interim application stage, where there had not been proper consideration of the evidence. In the instant case, the assessment of the evidence must wait until trial. To dismiss the case at the interim application stage would be to conduct a mini-trial, which would be inappropriate at a summary judgment hearing.
This decision serves as a reminder that for summary judgment to succeed, a party must present strong evidence that the claim has no real prospect of success. In delivering his judgment, Teare J noted that the classic circumstance in which a court might determine, before trial, that a claim has no real prospect of success, is where contemporary documents show that the Claimant’s evidence cannot be true. That was not so in the present case.
Privilege – Inadvertent disclosure
In Atlantisrealm Ltd v Intelligent Land Investments Ltd  EWCA Civ 1029, the Court of Appeal provided guidance in relation to the circumstances in which the Court would consider inadvertent disclosure of privileged material to be an “obvious mistake”, such that it would grant an injunction preventing reliance on the document by the recipient.
In this case, a privileged email, which was unhelpful to the Defendant’s case, had been disclosed by mistake. The Claimant refused to delete the email, claiming that privilege had been waived. At first instance, the Court considered that the tagging of the email for disclosure by a junior lawyer engaged by the Defendant had been a conscious decision. Furthermore, the Court found that it was not an obvious mistake from the point of view of two solicitors acting for the Claimant who separately inspected the Defendant’s disclosure.
The Court of Appeal disagreed with the judge. First, the disclosure had been a mistake on the part of the junior lawyer, and neither the supervising partner nor the client had made a considered decision to disclose the email. Secondly, the mistake was obvious to the more senior of the two solicitors engaged by the Claimant, as was apparent from an email which he wrote to the Defendant’s solicitors about their disclosure of the privileged email.
In granting the injunctive relief sought by the Defendant, the Court of Appeal noted that in the electronic age mistakes will occur from time to time, and that where inadvertent disclosure of privileged material occurs, it is for the solicitors to co-operate honestly in putting matters right.