Corporate Law Update

This week: Changes to the UK’s domestic merger control regime will come into effect next month, an exclusion clause prevented a party from claiming loss of profit arising from the other party’s total failure to perform, and the Government confirms it intends to publish draft legislation this Summer to require companies to publish CEO-to-average workforce pay ratios.

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National security changes to merger control regime implemented

The legislation implementing the Government’s proposed short-term changes to the UK domestic merger control regime has been published. The Enterprise Act 2002 (Share of Supply Test) (Amendment) Order 2018 (the “SST Order”) and the Enterprise Act 2002 (Turnover Test) (Amendment) Order 2018 were both made on 14 May 2018.

The changes come into effect on 11 June 2018.

The UK's domestic merger control regime currently allows the Competition and Markets Authority (CMA) to review certain transactions that satisfy one or both of two tests: the “turnover test” and the “share of supply test”.

The Orders make two principal changes to these tests:

  • Turnover test. A transaction currently falls within the regime if the turnover of the target being acquired exceeds £70 million. This threshold has now been lowered to £1 million where the target is a “relevant enterprise”.
  • Share of supply test. A transaction falls within the regime if it results in the creation of a combined share of supply or purchases of any goods or services of a particular description of 25% or more within the UK.

    Now, if the target is a “relevant enterprise”, there is an additional share of supply test that applies only to the target’s share of supply (and not the combined share). This test is if the relevant enterprise has an existing share of supply of at least 25% of the goods or services that make it a relevant enterprise. In other words, the test can be satisfied even if the share of supply does not increase as a result of the transaction.

The SST Order includes a list of activities that will make a business a relevant enterprise. As expected, these include (broadly) developing or producing goods that are subject to export controls (including dual-use technology), as well as quantum computing and computer hardware, firmware or software that performs critical security or low-level control functions (such as “rooting” software).

The list also includes the proposed broad category of: “owning, creating or supplying intellectual property relating to the functional capability of: (i) computer processing units; (ii) the instruction set architecture for such units, (iii) [or] computer code that provides low level control for such units”.

In its consultation response, the Government explained that it had restricted this category to “processing units” in order more clearly to target national security risks. However, the SST Order does not explain or define the term “processing unit”, nor does it say what is meant by “functional capability”. These terms will presumably need to be read with their plain meaning.

The result of this may be that any business that develops computer software, patents or other processes which in any way affect a computer’s processor could potentially fall within the new category of a “relevant enterprise”.

If that is right, the changes could bring many transactions within the CMA’s purview that currently come nowhere close to scrutiny.

Potential buyers of these kinds of business will need to analyse carefully whether any software or processes developed by the target business could in any way affect a computer’s microprocessor, processing unit or control unit to decide whether the modified tests apply.

More generally, buyers of UK businesses will now need to:

  • analyse whether the target business falls within any of the new categories of activity that constitute a “relevant enterprise”;
  • if it does, conduct turnover and share-of-supply analyses based on the new tests to decide whether their deal falls within the modified regime; and
  • if it does, decide whether voluntarily to notify the CMA, in the knowledge that the transaction could potentially trigger a national security review.

Innocent party could not claim loss of profits for non-performance

The High Court has held that a supplier under a contract was not able to claim for loss of profit that arose when the other party failed entirely to perform its obligations under the contract.

What happened?

In Motortrak Ltd v FCA Australia Pty Ltd, Motortrak and FCAA entered into a contract under which Motortrak would supply web-based marketing services to FCAA.The contract contained an exclusion clause stating:

[N]either party shall be liable  to the other for:

(i) any indirect or consequential loss or damage at all; or
(ii) any loss of business, capital, profit, anticipated saving, reputation or goodwill, arising out of or in connection with the Agreement or its subject matter.

In due course, FCAA came to believe that Motortrak had paid bribes to a company owned by FCAA’s former managing director (MD) to ensure that FCAA entered into the contract with Motortrak.

Eventually, FCAA treated itself as entitled to rescind the contract due to its former MD’s breach of duty. It told Motortrak to cease providing services and it stopped paying Motortrak’s invoices.

In the event, the court said FCAA was not entitled to rescind the contract, because it had continued to observe the contract after suspecting the bribes had been paid and so had “affirmed it”. As a result, when it stopped paying the invoices, FCAA committed a repudiatory breach of contract.

In response to this repudiatory breach, Motortrak terminated the contract and claimed (among other things) for damages for loss of profits. FCAA said it was not liable for loss of profit, citing the exclusion clause above.

Motortrak argued that the clause should apply only where loss of profits arises “in connection with the performance of the contract”, and not where FCAA simply refused outright to perform the contract. It said that, otherwise, the exclusion clause would deprive FCAA’s obligations of all contractual force.

What did the court say?

In short, the court agreed with FCAA.

Under English law, if an exclusion clause is unclear or ambiguous, the court must interpret it against the person trying to rely on it (in this case, FCAA). This is known as the “contra proferentem rule”. However, this case highlights two important limits to that principle:

  • If the clause is mutual and works both ways, the rule does not apply. In this case, the exclusion clause was reciprocal, so the court could not interpret it against FCAA.
  • The rule applies only if the exclusion clause is ambiguous. In this case, the court said the wording of the clause was clear, even if its effect would be to deprive Motortrak of any real remedy.

To support Motortrak’s claim, the court would have had to read language into the contract that was not necessary to make it work; essentially, to imply terms into the contract. It was not prepared to do this.

As a result, Motortrak had no claim against FCAA.

Practical implications

There are numerous cases that show how fragile exclusion clauses in contracts can be if not worded properly. This case is remarkable because it shows how a clearly and possibly inappropriately drafted exclusion clause can, conversely, lead to a contract party having effectively no remedy at all.

This judgment is a stark reminder of how critical it is to draft an exclusion clause carefully in the context of the contract in question. It is worth bearing the following in mind when drafting:

  • Make the exclusion as clear as possible. Any uncertainty could result in the court implying terms the parties did not anticipate or in the clause being interpreted against the party relying on it.
  • What kinds of breach should the exclusion clause cover? Consider whether the exclusion should not apply to a total failure to perform (as happened in this case).
  • Make it clear whether the exclusion clause covers non-contractual claims. These might include tortious claims (such as negligence or misrepresentation) or claims for breach of duty. The contract will need to make it abundantly clear exactly what liabilities are being excluded.
  • In most business-to-business (B2B) contracts, an exclusion clause will be governed by the Unfair Contract Terms Act 1977. Depending on what the clause is trying to exclude, either it will be void completely, or it will be enforceable only if it is reasonable.
  • For this reason, try to structure exclusion clauses using sub-paragraphs, or separate different exclusions out entirely. That way, if a court decides that part of the clause is enforceable but another part is not, it can “sever” (or delete) the offensive part and leave the rest intact.
  • Do not confuse loss of profit and indirect loss (or consequential loss). A loss of profit can be indirect, but often it will be direct. Simply excluding indirect loss will not necessarily exclude all loss of profit. The exclusion clause above shows how to separate the two concepts elegantly.

Draft pay ratio reporting legislation expected in the Summer

In response to a written question, the Government has confirmed that it intends to publish draft legislation this Summer to require companies to report annually on the pay ratio between their CEO and the average worker.

The legislation will follow the Government’s consultation on corporate governance reforms, published in November 2016, and its response statement in August 2017. In that response, the Government said it intended to introduce “a pay ratio reporting requirement for quoted companies comparing the pay of the chief executive officer with that of pay in the wider UK workforce”.

The response by Andrew Griffiths MP states that the detail of the pay ratio-reporting proposals has been developed since then through two phases of informal consultation with a balanced range of stakeholders.