Corporate Law Update
- Draft legislation is introduced to expand the UK’s scheme under which dormant investments can be transferred to charitable causes
- The court holds that a notice of claim under a tax covenant was sufficiently detailed after all
- False responses made to a buyer’s due diligence enquiries amounted to fraudulent misrepresentations
- Draft legislation is introduced to expand the power to disqualify former directors
- The Financial Reporting Council publishes a thematic review of interim reporting by listed companies
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Draft legislation has been introduced into Parliament to expand the UK’s Dormant Assets Scheme. If enacted, the Dormant Assets Bill will extend the Scheme to cover other classes of investment, including listed securities.
Currently, the Scheme allows participating banks and building societies to apply monies standing to the credit of long-dormant bank accounts towards charitable purposes if they are unable to establish contact with the owner of those monies. The monies are transferred to the Authorised Reclaim Fund (the ARF) – Reclaim Fund Limited – and, from there, distributed to good causes across the United Kingdom.
Under the expansion, the Scheme will apply to proceeds and distributions from other kinds of financial products and instruments, including insurance and certain retirement income policies, shares in collective investments and investment assets, and shares in certain publicly traded companies.
In each case, the Scheme will be voluntary. A financial institution or company will need actively to opt into the Scheme to be able to donate to the reclaim fund.
As is currently the case, proceeds will be transferred into the Scheme only if they are “dormant”. Before transferring assets into the Scheme, an organisation will need to follow the TVR procedure – Trace the asset owner, Verify their identity, and attempt to Reunify them with their asset.
If assets are transferred into the Scheme and the owner later resurfaces, they would be able to claim compensation directly from the Scheme. The Scheme is effectively underwritten by the ARF, which holds a certain amount back to meet potential compensation claims.
In relation to securities in publicly traded companies, the key aspects of the proposed Scheme, as set out in the Bill, are as follows:
- The Scheme would apply only to companies whose shares are traded on a UK regulated market or a multilateral trading facility (MTF). This includes the London Stock Exchange Main Market and High Growth Segment, AIM and the AQSE Main Market and Growth Market.
- The company would be able to transfer dormant distributions payable on shares (including dividends) and dormant proceeds from “corporate actions” to the ARF. (“Corporate actions” is not defined in the Bill, but the consultation contemplated proceeds from transactions such as a takeover or a scheme of arrangement.)
- To transfer proceeds to the ARF, the proceeds would need to have been dormant for at least 12 years. Broadly, this means that the shareholder has not communicated with the company, or the funds have remained unclaimed, for that period.
- If the company does transfer proceeds to the ARF, the shareholder in question would no longer have a right to claim against the company to recover their funds, but they would gain a corresponding right of compensation from the ARF.
- However, the extended Scheme would only capture proceeds relating to shares held by an individual. A company would not be able to donate proceeds to the ARF if they relate to shares held by a corporation. In reality, this could well limit the scope of the extended Scheme, as most shares in publicly traded companies are held through intermediary organisations (such as, for example, a CREST nominee) and so would appear not to fall within the Scheme.
- Transferring dormant distributions or proceeds would not itself amount to a breach of duty by the company’s directors or give rise to any liability for the directors or the company. However, it seems to us that the directors of a company would clearly need to consider any other uses to which they can put distributions or proceeds before making a decision, bearing in mind their general duties to their company.
The Government has previously estimated that the expanded Scheme could potentially release up to £880 million of dormant value for good causes within the UK. It now intends to legislate for the expanded Scheme as Parliamentary time allows.
Macfarlanes is proud to have assisted the Government on the proposed expansion of the Dormant Assets Scheme.
The Court of Appeal has reversed a decision by the High Court that a notice of claim under a tax covenant was invalid because it did not state in reasonable detail the matter giving rise to the claim.
Dodika Ltd v United Luck Group Holdings Ltd  EWCA Civ 638 concerned the sale of shares in a company whose business was the development of mobile game applications.
The sale was governed by a sale and purchase agreement (SPA). The SPA included a tax covenant given by some of the sellers in favour of the buyer, under which the sellers promised to reimburse the buyer for any tax liabilities of the target group relating to events that occurred before the sale.
The SPA stated that the buyer could bring a claim under the tax covenant only if it “gave written notice … stating in reasonable detail that matter which gave rise to such Claim, the nature of such Claim and (so far as reasonably practical) the amount claimed” before a specified deadline.
Shortly before the deadline, the buyer sent the sellers notice of a claim under the tax covenant relating to an investigation by the Slovene tax authority into the group’s transfer pricing policies.
The notice cited the relevant provisions of the SPA, including the tax covenant. It also confirmed that the claim under the tax covenant related to an investigation by the Slovene tax authority and set out a brief chronology of events concerning that investigation. However, as the investigation was ongoing, it was not possible at the time to include the amount the buyer was claiming.
The sellers rejected the notice on the basis that it did not state the amount of the claim and had not provided reasonable details of the “matter which gave rise” to the claim.
The High Court held that the notice was not invalid by virtue of failing to state amount of the claim. However, it said that the mere reference to “an investigation by the Slovene Tax Authority … into the [subsidiary’s] transfer pricing activities” did not provide the sellers with sufficient information to identify the matter giving rise to the claim. Instead, the notice should have explained “the reasons why a tax liability might accrue”, which, in this case, meant setting out details of the relevant transactions.
You can read more about the High Court’s decision in our previous Corporate Law Update.
The buyer appealed to the Court of Appeal.
What did the court say?
The Court of Appeal said that the notice had been valid.
The judges agreed that the matter giving rise to the claim was indeed the target group’s transfer-pricing practice, rather than the mere fact of a tax investigation. However, they felt that the notice had provided reasonable details of the issues arising out of that practice for the purposes of the SPA.
The court gave various reasons for this:
- The sellers had already been aware of the detail of the tax authority’s investigation. The judges agreed that a notice which did not comply with the SPA would be invalid, even if the sellers already knew about the matter in question. But they also felt that information conveyed by a notice was informed by the background context, including any knowledge which the sellers in fact had.
- There was very little specific detail available to the buyer. Although the notice contained very limited information on the investigation, any further detail available would have described the transfer pricing practice at only a high level. The tax authority had not at that point identified any specific transactions that it was challenging.
- The notice had to be read in the context of the commercial purpose of the requirements in the SPA. This was to enable the sellers to make enquiries into the factual circumstances of the claim so as (so far as possible) to assess its merits. It served no commercial purpose to set out further “limited and generic detail” or to recite facts which the sellers already knew. This would have reduced the notice requirements to “empty formalism”.
What does this mean for me?
The court’s decision is interesting. There is a long-standing principle that, where a contract requires a notice to contain prescribed information, it must do so. If it fails to, it will be invalid. The court must judge this based on what a “reasonable recipient” would understand by the notice, rather than by what the actual recipient may or may not have understood.
However, the court clearly felt that it was able to take the sellers’ actual background knowledge into account, framing the question as one of what a “reasonable recipient with the (assumed) knowledge of both parties” would understand. As a result, the brevity of the notice in this case did not render it invalid, whereas, in another set of circumstances, it might well have.
It is always important to view these decisions in context. In this case, the sellers had been informed throughout the course of the investigation and had even been represented in proceedings with the tax authority. This will not be true in every case.
There is always a degree of tension between, on the one hand, ensuring that a seller is not blindsided by a vague claim with very little information to understand what is being claimed and, on the other hand, requiring a lengthy and formulaic recitation of facts known to both sides. Often the court will take a pragmatic approach, but there are certain steps a buyer can take to shore up their position.
- Observe the notice requirements in the SPA. These can vary from case to case, and failure to comply with any specific requirement can nullify a notice. In this case, the SPA required “reasonable detail” of the claim. However, in another case on which we recently reported, a notice was invalid because it did not set out “full particulars” of the claim, as required by the SPA.
- Provide as much detail of the claim as is reasonably possible. This entails striking a balance between providing enough detail to ensure the seller understands the claim and not stating the buyer’s case so exhaustively that the notice effectively rules out other avenues of claim.
- Consider whether there are any other breaches of the SPA. If there are, set them out separately. The more lines of attack a buyer pursues, the more success it is likely to have.
The High Court has examined whether false responses given by sellers to a buyer’s due diligence enquiries amounted to fraudulent misrepresentations.
The court also had to decide whether the responses amounted to breaches of warranty in the relevant share sale agreement (SPA). We will look at this in next week’s update.
MDW Holdings Ltd v Norvill  EWHC 1135 (Ch) concerned the sale of a waste management company whose business included the processing and disposal of dry and wet waste.
The company’s business was heavily regulated. In particular, it required an environmental permit to operate a regulated facility and consent from the relevant water company to discharge trade effluent into public sewers. The permit and the discharge consent were subject to various conditions. In particular, the discharge consent set limits on the level of contaminants permitted in the effluent and required the company to keep detailed records of all effluent it discharged.
Between 2013 and October 2015, sampling showed that certain contaminants in the effluent exceeded the permitted limits in the discharge consent. The water company wrote to the business requiring remedial action. The parties agreed an improvement plan, but the effluent continued to include at least one contaminant above prescribed limits.
The water company subsequently made several requests for the company’s internal test results. In response, the company’s general manager provided figures for copper and lead levels that had been falsified. The company also asked the water company to increase the permitted limit for ammonia under the discharge consent, but the water company declined to do so.
From late 2014, the sellers entered negotiations with an interested buyer to sell their shares in the company. The buyer carried out environmental due diligence, which included sending the sellers a legal due diligence questionnaire.
Among other things, the questionnaire asked for details of “any investigation, enquiry, prosecution or other enforcement proceedings or process by any governmental, administrative, regulatory or other body or organisation in relation to, or affecting, [the company]”. The company’s response failed to mention the ongoing breaches of the discharge consent or to provide details of the communications between the company and the water company concerning the discharge consent breaches.
On 14 October 2015, the sellers and the buyer signed the SPA and completed the sale.
Among other things, the SPA contained an “entire agreement clause”, which stated:
This agreement constitutes the entire agreement between the parties and supersedes and extinguishes all previous discussions, correspondence, negotiations, drafts, agreements, promises, assurances, warranties, representations and understandings between them, whether written or oral, relating to its subject matter.
What did the buyer claim?
Following the sale, the water company sent an email to the company alerting it to further breaches of the discharge consent in respect of ammonia levels and warning it that a prosecution for historic breaches was being considered.
The buyer subsequently notified the sellers that it intended to claim against them for failing to disclose the breaches of the discharge consent and on the basis that the company had been systematically breaching environmental law.
The buyer’s claim was based on two separate actions:
- Breach of contract on the basis that several of the warranties which the sellers had given in the SPA were inaccurate.
- Misrepresentation, on the basis that the sellers had made several pre-contractual statements that were inaccurate or false.
Below, we discuss the buyer’s claims in misrepresentation. We will look at its claims for breach of warranty next week.
What did the buyer claim?
The buyer claimed that it had relied on written statements in the sellers’ responses to the due diligence questionnaire when deciding whether to enter into the SPA. It argued that these statements amounted to pre-contractual representations and had been false.
The buyer claimed in both negligent misrepresentation under the Misrepresentation Act 1967 and fraudulent misrepresentation (or “deceit”) at common law. The key distinction between these actions is the level of damages the court will award (although there are others). Broadly, if a misrepresentation is fraudulent, the buyer can recover all losses arising from it, whereas if it is merely negligent, the buyer can recover only losses that were reasonably foreseeable.
The sellers denied that they had made any misrepresentations at all. However, they also argued that, if they had made misrepresentations, their liability was excluded by the entire agreement clause.
What did the court say?
The court found that the sellers had made fraudulent misrepresentations.
In assessing the buyer’s claim, the judge addressed several interesting points.
- The sellers’ corporate finance adviser had provided the responses to the buyer’s due diligence questionnaire, not the sellers themselves. However, the court said the corporate finance advisor had been acting as the sellers’ agent and so the sellers were liable for its responses.
- The buyer had relied on the responses to the questionnaire when entering into the SPA. The judge noted that “[the buyer’s] reason for asking the questions can only have been that it wanted to know the answers, and its reason for wanting to know the answers can only have been because they would inform its decision whether to buy the shares.”
- Several of the responses to the questionnaire had been inaccurate, including, in some cases, because the sellers had omitted information that was relevant to the context of those statements. However, there was no evidence that the sellers had made oral or implied representations.
- One of the sellers (who was also the company’s CEO) had known of the relevant matters, including the falsified data that had been provided to the water company. His statements were therefore dishonest and amounted to fraudulent misrepresentations.
- The other sellers were also liable for the fraudulent misrepresentations, even though they had not acted dishonestly, because they had left the negotiation and handling of the sale to the CEO. He had therefore been acting as their agent and so they were responsible for his fraud.
- The entire agreement clause did not exclude liability for misrepresentation. The purpose of the clause was to clarify that nothing said, written or done before signing the SPA created any contractual obligations or liabilities. The SPA contained nothing to the effect that the buyer had not relied on any pre-contractual statements or that liability for misrepresentation had been excluded.
Interestingly, the judge did not feel that the water company’s concerns over the persistent breaches of the discharge consent and its ongoing monitoring of the company’s activities amounted to an “investigation, enquiry or enforcement action”. As a result, the response that there were no investigations, enquiries or enforcement action had not amounted to a misrepresentation.
What does this mean for me?
This is a useful reminder of the importance of taking steps to ensure that responses to pre-contractual enquiries are accurate. In this case, the question arose on the sale of a business, but this could apply equally on the sale of some other kind of property.
Here, the risk to the sellers was exacerbated by the negotiations being left to only one of the sellers, and responses to the buyer’s enquiries being further delegated to a professional adviser. Even though most of the sellers were not involved in responding to enquiries, they nonetheless found themselves liable for the misrepresentations.
There are, however, various steps sellers can take to minimise the risk of liability for misrepresentation when responding to enquiries from a buyer:
- Ensure your responses are complete and accurate. Clearly responses must not be outright false. However, a response can be inaccurate for a variety of reasons, including if it lacks key context or information and so gives a misleading impression.
- Even if not preparing or compiling responses to a buyer’s enquiries, ensure that you have oversight of what is being said. Review any written responses to enquiries and ask for a summary or minutes of any meetings or telephone calls.
- Include appropriate protections and limitations in the SPA. As this case shows, an entire agreement clause of the kind in this case, whilst seemingly broad, will not prevent a claim for misrepresentation. The courts will insist on clear wording if the parties are to exclude any remedies provided for by the law.
- Appropriate protections could include a non-reliance clause, which confirms that the buyer had not relied on any pre-contractual statements when entering into the SPA. Better yet is an express exclusion of liability for misrepresentation. This can be coupled with a waiver of any non-contractual damages, such as rescission or damages calculated on a tortious basis.
The decision is also a useful reminder that the question of misrepresentation is still relevant on a share or business sale. Recent cases, such as Idemitsu Kosan Co Ltd v Sumitomo Co Corp  EWHC 1909 (Comm), have confirmed that a contractual warranty cannot also amount to a pre-contractual representation, significantly cutting back the scope for a buyer to bring a claim in misrepresentation.
However, this does not mean that a misrepresentation claim is not possible. The buyer will need to show, as it did in this case, that there was in fact an inaccurate pre-contractual statement and that the buyer relied on it when deciding whether to enter into the sale.
Also this week…
- New Bill to expand power to disqualify directors. New draft legislation has been introduced which, if enacted, will expand the powers of the court to disqualify former directors of dissolved companies. In particular, the Bill would enable the Secretary of State and the Official Receiver to investigate the conduct of former directors of dissolved companies without needing to restore the company to the register and to begin disqualification proceedings in appropriate circumstances.
- FRC publishes thematic review of interim reporting. The Financial Reporting Council (FRC) has published a thematic review of interim reporting by listed companies. The exercise comprised a desktop review of the interim reports of 20 companies on the London Stock Exchange’s Main Market whose interim reporting period ended between June 2020 and September 2020. The FRC notes that most companies have heeded recommendations from its previous thematic reviews and joint guidance by the FRC, the Financial Conduct Authority and the Prudential Regulation Authority on reporting during Covid-19. However, the FRC has made some specific recommendations for companies in relation to balance sheet movements, impairments, alternative performance measures and going concern disclosures.