Facts

The businesses involved in this action sold extended warranties relating to satellite television dishes, digital boxes and associated equipment. They targeted people who had bought satellite systems and whose warranties were about to run out.

Digital Satellite Warranty Cover Limited (“DSWC”) and Mr Bernard Freeman and Mr Michael Sullivan (who traded in partnership as Satellite Services (“SS”)) entered into agreements to repair and replace customers’ satellite television equipment in the event of not only breakdown or malfunction but also accidental damage (“the Warranties”).

DSWC and SS’ contractual obligations under the Warranties were to repair or replace the faulty or damaged equipment. There was no obligation to pay money in respect of the repair or replacement costs incurred by the customers under the Warranties.

The FSA brought an action against DSWC and SS on the basis that they were selling and carrying out insurance contracts without proper authorisation required under the Financial Services and Markets Act 2000 (“FSMA”).

In the High Court Warren J held that the Warranties were “contracts of general insurance” for the purposes of FSMA and therefore were a regulated activity, for which DSWC and SS did not have the requisite FSA authorisation. This decision was upheld by the Court of Appeal.

The Legislation

Section 19 of FSMA prohibits anyone carrying out regulated activity in the UK unless they are an authorised person or exempt. Article 3(1) of the Regulated Activities Order 2001 (“RAO”) defines contracts of general insurance as “any contract falling within Part I of Schedule I”. This sets out specific classes of risk and the main class that was under consideration in this case was Class 16 that sets out “miscellaneous financial loss”, namely

“Contracts of insurance against any of the following risks,

(a)     risks of loss to the persons insured attributable to interruptions of the carrying on of business carried on by them or to reduction of the scope of business so carried on;

(b)     risks of loss to the persons insured attributable to their incurring unforeseen expense (other than loss such as is covered by contracts falling within paragraph 18);

(c)     risks which do not fall within sub-paragraph (a) or (b) and which are not of a kind such that contracts of insurance against them fall within any other provision of this Schedule.”

The court had to decide whether the Warranties were contracts of insurance and, if so, whether their activities fell within Schedule I of the RAO.

The Court of Appeal Judgment

The Court of Appeal upheld the decision of Warren J that the Warranties fell within Class 16(b) – risk of loss attributable to the insured incurring unforeseen expense. The risk covered by an agreement that provides for the repair and replacement of equipment and an agreement that provides an indemnity for the costs involved are essentially the same. They both contain the risk of the breakdown of equipment that will lead to an unforeseen expense on behalf of the insured.

Patten LJ said that although the Warranties provided for the risk of malfunction to be dealt with by way of repair or replacement it was essentially a financial one.

The judgment also addressed whether there could be “contracts of insurance” at common law which are not caught under Part 1 of Schedule 1 of the RAO and are therefore unregulated. The FSA submitted that Class 16(c) was a catch all sub class and Patten LJ was inclined to agree:

“Their [FSA's] first submission is that the RAO provides a complete code for the regulation of non-life business which encompasses every contract of insurance. As a corollary to this they also contend that class 16(c) is a catch-all provision which is intended to apply to any contracts of general insurance which do not fall within one of the other classes or within classes 16(a) or (b) … my own view is that this is probably right and that class 16… (was intended to be the catch-all which the FSA contends for and is not limited to residual cases of financial loss.”

Comment

Extended warranties are extremely common in the retail market and are often called “service contracts” as they provide an extended period of repair and maintenance for a product that a customer would otherwise be required to pay for themselves. They are widely marketed and sold by many major retailers. The Warranties under consideration in this case are very similar to service contracts and this decision raises questions in relation to the legality of such extended warranties.

Therefore, this case may have direct implications for those selling or providing extended warranties for various consumer goods and appliances on an unregulated basis. Unregulated providers and sellers of such extended warranties will need to consider whether they need to be FSA regulated.

There are two main categories of legal professional privilege, namely litigation privilege and legal advice privilege: litigation privilege applies to documents brought into existence for the purpose of litigation; legal advice privilege may apply to communications between a client and lawyer in which legal advice is sought or given.

The Facts

The Defendants, S and A, applied to the Court for relief from sanctions under Part 3.9 of the Civil Procedure Rules (which sets out the grounds for relief from sanctions) in relation to their failure to comply with an unless order.  The unless order related to the disclosure of materials seized from a storage facility belonging to S’ brother pursuant to a search order.  At that facility there were fourteen boxes containing what appeared to be client files of S and A’s solicitors, together with some loose papers.  Those documents were kept by the “supervising solicitor” (the independent solicitor who monitors search orders).

Leading Counsel instructed by the supervising solicitor carried out an initial review of the documents for potential grounds of legal professional privilege.  In relation to the documents Leading Counsel found may potentially be privileged S and A were ordered to identify which documents they asserted privilege over with sufficient particularity of the claim to privilege. 

S and A’s solicitors applied for and were granted two extensions in which to comply, although the second order was in the form of an unless order, pursuant to which if they did not comply they would be debarred from claiming privilege over all of the documents in respect of which there had been no claim to privilege.  If there was only partial compliance, they could still claim privilege over those documents where a proper claim to privilege had been made.

S and A served a schedule claiming privilege over initially 2,069 documents (subsequently reduced to 243) with only a generic description of the nature of the claim to privilege.  The Claimant successfully applied for an order that S and A had failed to comply with the unless order.  The consequence of this was that the unless order automatically took effect (and hence S and A could not claim privilege over any of the documents).

Subsequently S and A again revised their schedule reducing the claim to privilege to 221 documents with fuller details provided as to the privilege claimed (known as the “221 Schedule”).  They applied to the Court for relief from sanctions for failing to comply with the unless order. 

The Claim for Privilege

When reviewing the issue of privilege the Court noted (and both parties agreed) that the right to assert legal professional privilege is a substantive legal right.  The burden of proof being on the party which claims privilege to establish that privilege applies.  In this regard a party claiming privilege set out something of its analysis of the documents or, in the case of litigation privilege, the purpose for which they were created.

In determining whether a document is subject to litigation privilege, the Court noted that it needed to make an objective assessment of the purpose of the person who created it.  This involves the Court determining the following questions: (1) at the time the document was created was litigation contemplated; (2) was the document created for the dominant purpose of obtaining legal advice for that litigation or in aid of that litigation; and (3) under the direction of which person or entity, objectively, were those communications created?

After reviewing the law on legal professional privilege, the Court considered whether the 221 Schedule complied with the disclosure order.  It did so in relation to each document for which privilege was claimed.  The standard set out in the order was deliberately not a high one – that any claim for privilege should be sufficiently particularised to enable the Claimant to decide whether to challenge the claim or not.  The Court held that although there were serious defects in the 221 Schedule it did contain enough detail to satisfy the order. 

Relief from Sanctions

The Court then considered whether it was appropriate to grant relief from sanctions.  It considered the checklist of relevant factors set out in CPR Part 3 (Part 3 deals with the Court’s case management powers).   

The Court noted that it could not envisage any circumstances where legal professional privilege could be directly overridden by a court order made in exercise of its case management powers, as the unless order was.  Although a party may indirectly forfeit the right to claim privilege (for instance by failing to claim privilege after being given the opportunity to do so within a reasonable time) a court should be very wary of allowing a potentially valid claim for privilege (however late it is made) to be indirectly overridden by the exercise of a case management power.  The right of a party to claim legal  privilege is afforded a very high level of protection by the law. 

Having reviewed the relevant factors in the checklist and noting that the Claimant was not seriously prejudiced by the lateness of the disclosure, the Court granted relief from sanctions, despite S and A’s “lamentable history of failure to comply with court orders”.

JSC BTA Bank v Shalabayev and another [2011] EWHC 2915 (Ch)

Contact: clarkhood@city-law.net

The issue was whether the allocation of share options which vastly differed between the female Claimant, Hosso, and her male comparator fell under the Equal Pay Act (EqPA) or the Sex Discrimination Act (see s.6(6) SDA).

Background facts

In August 2009 the Employment Tribunal (ET) held that Hosso’s claim under the EqPA succeeded. She was awarded £34,542.36. Hosso appealed the amount of compensation awarded and the Respondent (ECM) appealed the finding that the EqPA claim succeeded.

The issue of whether the EqPA should have succeeded depended on whether the claim relating to the share option scheme should have been brought under the EqPA or the SDA and that was dependent upon the construction of s.6(6) SDA.

If the claim was found to be brought under the SDA, the claim would fail, as Hosso’s former solicitors failed to issue the SDA claim within the  time limit.

Hosso was a Senior Research Analyst working under the title of Head of Financial Institutions and Emerging Market Research. Her contract of employment was signed on 12 July 2002 and in 2003 ECM set up a share option scheme (the scheme). This was not mentioned in her contract as it pre-dated the scheme.

Hosso was granted share options for each the year the scheme operated between 2003 and 2006, but her male comparator was granted many more share options under the scheme.

Legal Principles

Section 6(6) SDA states:

“Subsection (2) does not apply to any provision for the payment of money when the provision of those benefits is regulated by the woman’s contract of employment”.

This subsection of the SDA renders it unlawful for an employer to discriminate against a woman employee in the way he affords her access to benefits.

Hoyland v Asda Stores [2005]  was considered by the Tribunal as it discusses s.6(6) SDA. In that case the ET found that the decision as to whether Hosso should receive her bonus in full was regulated by the bonus scheme. Relying on that finding of fact, the EAT held that the case fell within the s.6(6) SDA exclusion, it was not an SDA claim as it was regulated by the contract. The tribunal in Hoyland decided that the important word in s.6(6) is ”regulated”. Lord Johnston said:

“We have no doubt that that entitlement, if it be such in law, arose out of the contract of employment and is regulated by it in the sense that but for the existence of the contract the employment scheme would not be paid and it is therefore being paid as a consequence of its very existence”.

Relying on Hoyland, the Tribunal in Hosso, found that share options could be considered as deferred pay and allowed the claim to be brought under the EqPA in those circumstances. It was held that the scheme was not an entirely discretionary arrangement and the way the options operated were contractual, having regarded to the Hoyland decision.

On Appeal

In the EAT, ECM argued that unlike in Hoyland, the allocation of share options at ECM was pre-determined by rules, and on the facts of the case, the scheme was genuinely discretionary and the s.6(6) exclusion was not engaged.

ECM also submitted that the grant of options was not contractual as the scheme post-dated Hosso’s employment contact and there was no finding of fact that there was an express or implied term. Further, ECM’s proposed that the rationale in Hoyland had been misunderstood. The Asda bonus scheme was non-discretionary because entitlement was determined by the scheme and eligibility to benefit under it. It was not regulated by the contract because the existence of the scheme depended on the contract of employment.

Hosso responded that the share option amount constituted deferred pay under the EqPA as is pension entitlement (see Barber v GRE [1990]). The question of whether the allocation of share options is discretionary was not the issue and Hosso referred to the words of Lord Johnston in Hoyland.

Hosso advanced the ET’s view that she was only entitled to take advantage of the share option scheme by virtue of her eligibility as a selected employee of ECM and that the contract of employment regulated that benefit.

The EAT decided that the case for the benefit being regulated by Hosso’s contract of employment failed on two grounds. Firstly the share option scheme was not incorporated into her contract of employment. However, even if it was incorporated, the scheme was genuinely discretionary as to the number of shares which the director decide to allocate.

Secondly, the EAT decided that the position was different to Hoyland, as in that case there was a clear entitlement to a fixed amount by way of bonus for all eligible employees, but that was not the case for Hosso. It was held that the scheme was wholly discretionary and this genuinely discretionary element of ‘pay’ was not covered by the EqPA because it was not regulated by the contract.

The EAT set aside the Employment Tribunal’s finding from August 2009 that the EqPA succeeds and allowed the Respondent’s cross appeal.

Appeal from the decision of the EAT

In February 2011, Hosso submitted that the EAT misdirected itself as it should have found that in Hoyland the grant of bonuses in question was not governed by the contract of employment. The EAT should have instead found that in Hoyland it was the status of Hosso as an employee which entitled her to participate in the Bonus Scheme and this was the determining factor which meant that the provision of the benefit was regulated by the contract.

Properly construing the judgement of Lord Johnston in Hoyland, the EAT ought to have found that the Appellants position was indistinguishable from Hoyland on the basis that unless she was an employee at the relevant time she was not entitled to participate in the share option scheme at all.

As in Hoyland her participation in the Scheme was “regulated” by her contract of employment. As the EAT ought to have found that the ultimate grant of options was discretionary is, on a proper construction of Hoyland, irrelevant. Simply because the conferment of a benefit involves an act of discretion on the part of the Employer, this does not mean it ceases to be regulated. The overarching Regulator of the Scheme was the contractual relationship between the Respondent and each of its Employees who were entitled to participate it its benefits.

In April 2011 Lord Justice Mummery granted Hosso permission to appeal on the basis of this argument.

Hosso’s submission provided that under s2ZA an EqPA claim had to be brought within six months of the last day on which the woman was employed in the employment. But this was subject to extensions for “stable employment”, “concealment” and “disability” cases, all introduced as a consequence of the decision of the ECJ and House of Lords in the Preston (Preston v Wolverhampton NHS Trust (No.2) [2001]) litigation. The amendments were made to ensure that domestic legislation complied with the principles of effectiveness and equivalence under EU law and Article 157 in particular. They added that Article 157 requires that “eachMemberState shall ensure that the principle of equal pay for male and female workers for equal work or work of equal value is applied”.

It was explained that as the cross–appeal to the EAT was confined to the argument that under s.6(6) “where the payment is discretionary the claim must be an SDA claim and not an EqPA clam”, the sole issue on appeal was therefore, whether the option benefits were “regulated by the women’s contract of employment” within the meaning of s.6(6).

Hosso provided that as in Hoyland, the focus must be on the word ‘regulated’ and when a woman’s contract is silent as to a particular payment, the word must be interpreted to include circumstances in which the benefit would be regulated by the woman’s contract of employment.

The receipt of option benefits was critically dependent upon the existence of the contact of employment and in that sense the entitlement was regulated by the contract, as in Hoyland.

Further, the Board’s discretion would be subject to guidance by virtue of an implied term in the contract of employment or by virtue of the background of the contract of employment. In Imperial Group Pension Trust Ltd v Imperial Tobacco LTD [1991] the implied term of trust and confidence constrained a company’s discretion to give or withhold its consent to rule amendments in a pension scheme. Similarly, in Clark v Nomura [2000] discretionary bonus schemes were subject to an implied term that the employer would not exercise its discretion irrationally or perversely. Further in Mallone v BPB the discretion held by a company under a share option was restricted in accordance with the ruling in Clark v Nomura.

The rules of the ECM share option Plan included Rule 3.1(A) the “Board, acting for and on behalf of ECM, may grant any Eligible Employee an Option over such number of Shares and at such Option Price and with such conditions of exercise as they may determine”.

Whether the discretion in this rule was constrained directly by an implied term of the contract, or indirectly by the implied term informing the interpretation of the rule, the result is the same. The discretion to grant options under the Plan was subjected to guidance or restriction by the contract of employment and hence was “regulated” by it.

In answer to the EAT’s finding that the share option scheme was not incorporated into the contract of employment, Hosso explained that firstly, the absence of any reference in the contract was unsurprisingly because the Scheme post-dated her contract and the contract was not kept up to date, referring to an out of date salary. The contract provided under the heading of Benefits; “may be subject to change” and had the contract been kept up to date, the Scheme would have been included as one of the discretionary benefits. Had the contract been kept up to date it would have referred to the Scheme but in any case, it is not a requirement that the relevant payment is incorporated as a term or part of the contract of employment.

Secondly, this is not a case where benefits are so entirely discretionary that they are not regulated at all. That can be seen by the fact the discretion to award share options had to be exercised in accordance with the purpose of the Scheme; to recruit and or retain certain employees. The discretion to award options would be subject to an implied term of the contract of employment. Each year ECM looked at the performance and duties of each employee in deciding what level of shares to grant. It would be a breach of the implied term of trust and confidence to consider one individual’s good performance but to ignore another’s equally good performance.

ECM replied that the word “regulated” in s.6(6) SDA must mean in some way that the contract itself confers an entitlement to the benefit in question, and, just as importantly, that it in some way determines the amount of benefit. Slade J’s statement in Small v Boots [2009] was cited:

“As is illustrated by the observations of Potter LJ in Horkulak, the use of the term discretionary in a bonus scheme may be attached to the decision whether to pay a bonus at all, its calculation or its amount. No doubt there are other factors to which discretion may be attached. In determining whether the reference to a discretionary bonus conferred any contractual entitlement, the employment judge should have decided to what aspect of the scheme the term discretionary was attached…”

ECM provided that there was no contractual entitlement on the part of Hosso to any grant of share options, and that the determination of the number of options to be granted, if any, was entirely discretionary.

ECM also rejected Hosso’s submission that had her contract been kept up to date it would have included the share options as a discretionary benefit and stated it was difficult for them to maintain she has a contractually entitled  where the bonus was excluded from the contractual benefits.

On these bases ECM submitted that, as the EAT found, Hosso’s contract did not regulate the share options she was granted.

ECM referred to the Home Office’s White Paper (Equality for Women Cmnd 5724) which distinguished between contractual and non-contractual benefits, explaining if the SDA is intended to apply to “non-contractual aspects of employment” it applies where, as in the present case, the provision of the benefit in question is not contractual.

ECM argued that it does not follow from the fact that Hosso was eligible for consideration for a grant only by virtue of being an employee that her contract of employment regulated that grant. S.6(6) would omit the words ‘when the payment of those benefits is regulated by the woman’s contract of employment’ if the Claimant’s approach was intended.

In response to Hosso’s argument about the implied term of trust and confidence, ECM said this merely describes what the employer may not do in exercising discretion, they do not provide guidance as to what the employer must actually do.

Finally, ECM submitted that Hosso’s contention that the claim should be considered under the EqPA conflicts with the wording of the EqPA s.1(2) which states “an equality clause is a provision which related to terms (whether concerned with pay or not)…”

ECM’s Additional Argument

ECM submitted that the EqPA requires either no term in a woman’s contract of employment corresponding to the equivalent term in a man’s or a term in a woman’s contract which becomes less favourable that the term of a similar kind in a man’s contract. The term “regulated” is s.6(6) should be interpreted in light of this principle.

ECM argued that as there was no term in Hosso’s contract of employment which was or became less favourable than a similar term in the contract of her comparator, there was no term on which the equality clause could bite and so her claim must fail. This was supported by s.8(5) of the SDA which tracks the wording of s.2(1) EqPA.

Hosso submitted that a “term” in s1(2) EqPA meant a distinct provision or part of the employment contract and accepted there needed to be such a term for the EqPA to bite; the operation of s1(2) EqPA may arise when the terms of the contact are found in several documents and may be partly written, partly oral.

Hosso explained how such an operation arises in several examples, two of which drew upon her contract:

Hosso and her comparator’s contract provided that salary “increase[s] are not automatic or contractual and entirely [sic] at the discretion of the Company”.

Supposing there was an increase to the man’s salary, but not Hosso’s. A claim for the difference in pay following the crystallisation of the exercise of discretion can nevertheless be brought as an EqPA claim. The statement that the increases are “not…contractual” only applies to the exercise of discretion, not its outcome. The promise of a defined pay rise to the man is a new express term, absent from his written contract, which is more favourable than the corresponding terms as to basic pay in the woman’s contract.

Hosso pointed out the employment contact which states the “company operates a bonus scheme which is entirely discretionary. The scheme does not form part of your terms and conditions of employment”. The clause goes on to set out circumstances in which the payment will not be paid. Hosso submitted that in a scenario where she was to be awarded a bonus of £1000 and her comparator £5000, a court or tribunal should not let the above statement deny contractual effect to the bonuses once awarded. This is because the decision to award a new bonus is a new express term of the contract  or it is an obvious implied term that an employer will pay an employee the bonus it has decided to award.

ECM’s objection that the contract of employment makes no reference to the share options, was addressed. Hosso noted that the Tribunal found that the scheme was not mentioned in her terms and conditions because the scheme post-dated the contract. If the Tribunal had addressed itself to whether each individual Share Option Agreement was part of her contract of employment, the inevitable answer was that it would be: the share options were an important part of her remuneration package. The only reason for not mentioning them in her contract was that they post-dated her contract. They explained that it was, in essence, no different from a bonus scheme which is not referred to in the written contract of employment but which is provided to the employee qua employee.

ECM’s contention that Hosso had separate contractual rights under each individual Option Agreement was considered. Hosso explained that if the Option Agreement was part of her contractual entitlement qua employee, this objection evaporates. Further there can be no objection in principal to rights under the contract of employment operating in parallel with separate contractual rights under an Option Agreement: as Imperial Tobacco on the parallel operation of rights in contract and trust.

Hosso summarised that the exercise of the discretion to grant Hosso share options was controlled by the implied term of trust and confidence. That term was not less favourable to her. In three years the crystallisation of the exercise of that discretion resulted in disparity in pay.

Hosso noted that there was a term in her contract of employment that she be paid the options awarded to her. If she was granted options but no Notice of Grant was given, her grant would be void. In this scenario she could bring a claim under her contract of employment on the basis that the promise to pay her the shares, made “by reason of [her] employment”, was an express term of the contract of employment. Or she could bring a claim under her contract of employment on the basis that the promise to pay her shares was an express term of the Option Agreement itself, granted to her “by reason of [her] employment”.

It followed that the term which “[became] less favourable” was the term in Hosso’s contract of employment that, in each of the years 2003-5, she was entitled to the options awarded to her under the relevant Option Agreement. The term became less favourable because she was awarded fewer options than her comparator in each of those years.

The equality clause  s.1(1) EqPA then bites on this disparity in pay. The disparity in pay in each of the years 2003-5 is modified by the equality clause under s.2(1) so as to provide for upwards equalisation, with the result that Hosso was entitled to the same share options as Mr Aspbury in each of the years.

ECM replied with the submission that because Hosso brought her proceedings outside the three month time limit for the SDA but within the 6 month time limit under the EqPA, she was seeking to argue that the EqPA has jurisdiction to her the claim.

ECM submitted that s.6(6) SDA is an exclusionary provision  that states “sub-section 2 does not apply to benefits consisting of the payment of money when the provision of those benefits is regulated by a woman’s contract of employment”. Adding Parliament might have enacted that “when the provision of benefits, consisting of the payment of money, is regulated by the woman’s contract of employment, a claim shall be brought under the Equal Pay Act 1970”.

ECM explained that to invoke the ET’s jurisdiction under s.2(1) it must be established that:

a. The claimant woman has a term of her contract which has been either modified or included by reason of an equality clause, and

b. There is a breach of that term.

ECM submitted that Parliament made its intention clear in section 8(5) of the SDA which provides:

An Act does not contravene section 6(2) if-

(a) It contravened a term modified or included by virtue of an equality clause, or

(b) It would contravene such a term but for the fact the equality clause is prevented from operating by section 1(3) of the Equal Pay Act 1970

It was submitted that Hosso had not asserted that there is a term of her contract which was modified or included by virtue of an equality clause. Instead she asserted that there was a term of her contract that she would be given share options in accordance with the share option scheme, yet her comparator was treated differently under the same scheme. ECM argued that the difference in their treatment was the way in which the discretion was exercised by ECM.

ECM accepted that the effect of Imperial Tobacco was that there is a default term within the contract of employment that each would be treated with trust and confidence. But this term was constant and neither included nor modified by reference to the equality clause. As such, s.8(5) SDA has no application in relation to it and it is not within s.2 EqPA.

ECM agreed that if the term entailed equal treatment with her male comparator she could have had a contractual claim but considered that the better construction of s6(6), is that the exercise of a discretion to pay a man more money than a woman that arises where an employer and the man and woman have a relationship of employment is not a payment ‘regulated’ by the contract of employment, although this was not determinative.

They added that in any event, they submit that there is no law or logic to force the 1970 Act to mean something that it does not mean.

ECM suggested that Hosso had initially used a “status” based argument for construing the word “regulated”, then an eligibility argument and now was pursuing a “contractual term” argument on the basis of express and implied terms.

ECM questioned the proposition that a separate term from an express term of the contract is implied into the contract of employment once a discretion has been exercised and stated that this is contrary to the ET’s judgement.

ECM disputed the necessity of having a wholly separate contractual term  on crystallisation of the exercise of discretion. Further, if a term were implied that an employee be paid the options awarded” it would apply to all of the contracts of those receiving options to it would still not bring the case within s. 2. There is no basis for finding the term was different according to the amount of share options awarded.

Although ECM agreed that the contract may be contained in more than one document, they noted that the Tribunal had not made a finding that the Scheme was incorporated into the contract and that there was no finding that the Tribunal had not found that the only reason that the contract did not include the share option benefit was because it was not kept up to date.

Lastly, ECM submitted that Hosso’s submissions came to no more than “because the share options amount to “pay” (within the meaning of Article 157 TFEU) and that it is better to channel such disputes through the EqPA.

The Court of Appeal is presently deliberating its judgment.

(Hosso v European Credit Management  UKEAT/0475/09/CEA)

The European Commission (EC) has recently published proposals to revise the Markets in Financial Instruments Directive (MiFID), referred to as MiFID II. The original Directive came into force in November 2007 and the new proposals aim to make financial markets more resilient and efficient.

These proposals included a number of measures that seek to address the issues raised by the financial crisis and has been influenced by a number of regulatory concerns.

MiFID is considered to be a key element of the Financial Services Action Plan (FSAP). Its 3 main objectives are to:

1. ensure an open and secure retail securities market;
2. provide a single market for wholesale financial services; and
3. establish prudential rules and supervision.

The second version of MiFID is intended to tackle some of the issues missed by the first Directive. However, it also addresses concerns over high frequency trading. MiFID imposed new rules for equity trading across Europe when it became law in 2007 but some traders argued that it should be expanded. Some suggested regulators should focus on the over-the-counter (OTC) markets.

MiFID II is expected to develop the current European regulatory regime from a principles based process toward a more American style rules based regulatory regime. It also extends the MiFID framework across asset classes and into markets in which central bid/offer markets and trade transparency have never existed before. This is expected to have a tremendous impact on how OTC markets function.

It is expected that MiFID II will take effect in 2012 and is aimed at tightening the rules that govern stock exchanges, electronic trading systems, investment banks and high frequency trading hedge funds.

 
Contact: edwardmiller@city-law.net

Firstly, it reiterates the rules of interpretation regarding statutory references in English law contracts:  where a provision of a statute is referred to and incorporated by reference in a contract the relevant provision of the contract will be interpreted as would the statutory provision. There may be circumstances in which it is clear from the background and factual evidence which is deemed admissible in interpreting the contract that the parties clearly intended a meaning different to the statutory meaning, but such cases would very much be the exception rather than the rule.   One may, for example, consider a different meaning where the statutory meaning flouts common sense – again, a very unlikely and rarely drawn conclusion.

Secondly, the Supreme Court held that Section 736 of the Companies Act which sets out a definition of the term “subsidiary” means what it says.  In particular, the references to “holding” voting rights are to be construed as excluding voting rights which may be acquired or controlled indirectly by agreement with the holder thereof.  In addition, the Supreme Court held that references in paragraphs (b) and (c ) of Section 736(1) to a company being a “member” of another company are to be construed strictly and in accordance with the meaning of the term “member” under English corporate law. A company will be a member of another company only if the first company is named in the register of members of the second company as a “member” (i.e. recorded as being the legal holder of shares).

In Farstad Supply v Enviroco Ltd, the Supreme Court held that a guarantee did not extend to cover the liabilities of an entity whose “parent” entity had issued a guarantee extending to the liabilities of the “parent’s” affiliates (which included “subsidiaries” as defined in the Companies Act). In that case the guarantor was not a member of the company in question (it had pledged its shares in the “affiliate” to a bank, pursuant to Scottish law, thereby ceasing to be recorded in the register of members as such).    The guarantor did not itself hold any voting rights in the affiliated entity and accordingly did not fall within another limb of the definition of “subsidiary”.   Accordingly, the Supreme Court held that the guarantor was not liable because the affiliated entity was not a “subsidiary” within the meaning of the term under Section 736 of the Companies Act.

It is worth noting the case not only as a warning for those drafting contacts – as  a general reminder as regards interpretation of statutory terms incorporated into contracts, but also given that where one has facts similar to those in Farstad what appears to be a potential error in drafting the statute could in fact produce an unexpected outcome.

Finally, one ought to note that company law in England as confirmed by this case provides that a company which does not itself hold voting control in another company will not be the parent of (and the other company will not be the subsidiary of the first company) unless the first company (a) is a “member” of the second company; and (b) either has the right to appoint a majority of directors of the second company or to exercise a majority of the voting rights in the second company.

(Farstad Supply A/S (Respondent) v. Enviroco Limited (Appellant) 2011 UKSC 16)

contact: ritapadam@city-law.net

SCARPs are complex financial instruments which potentially provide income to investors but also leave them exposed to large capital losses.  The FSA reported that between January 2007 and December 2009 Credit Suisse UK customers clients invested over £1 billion in SCARPs.  However, during that period there were a number of serious failings in the systems and controls in respect of those sales.  These included:

• Inadequate systems and controls in relation to assessing customers’ attitudes to risk;
• Failing to take reasonable care to properly evidence the suitability of SCARPs for customers; and
• Failing to monitor staff effectively to ensure that they took reasonable care when giving advice.

Concerns were identified by the FSA during a supervisory visit to the firm and this led to subsequent FSA enforcement investigation.  The FSA said in a statement that “Credit Suisse UK had poor systems and controls in place and failed to maintain adequate records regarding its advice on these products”.

These failings amounted to a breach of Principle 3 as set out in the FSA Handbook.  Consequently customers were exposed to an unacceptable risk of being sold a SCARP that was unsuitable for them.

Tracey McDermott, acting director of enforcement and financial crime, said:

“We have seen all too frequently the consequences of financial services firms failing to implement proper systems and controls to ensure their customers invest in suitable products.  A proper assessment of customers’ individual needs and circumstances is even more critical where firms are selling complex products like SCARPs.”

The FSA also stated that:

“Credit Suisse UK’s systems were not up to the level we, and their customers, are entitled to expect.  Our recent ‘Dear CEO’ letter to the wealth management industry made it clear that significant and widespread failings exist in this area and standards need to improve.  This penalty should leave firms in no doubt about our determination to make that happen.”

The FSA reported that since the discovery of these failings, Credit Suisse UK has made a significant number of changes to its advisory processes and has enhanced the systems and controls in place to ensure the suitability of its advice to its customers.  The FSA statement also notes that Credit Suisse UK has agreed to carry out a past business review, overseen by an independent third party, in relation to SCARP purchases during the period identified.  Credit Suisse UK has agreed to pay compensation to anyone who lost money buying these products.  It received a 30% discount on the fine for agreeing to pay up early.  The full fine would have been £8.5 million.

 The FSA has since been forced to suspend investigations on Keydata Investment Services Limited (in administration) (Keydata).

Facts:

Keydata was an investment manager specialising in the design and distribution of structured products for individual investors, and also provided third party administration services for financial institutions. Keydata had been investigated by the FSA for contravention of FSA’s rules in relation to the selling and marketing of one of Keydata’s products, breaking tax laws and concerns over ‘potentially missing assets’. It then applied for Keydata to be placed in administration in June 2009 with the intention to protect investors on the grounds of it being insolvent. Keydata’s business was also referred to the Serious Fraud Office.

The founder and chief executive of Keydata, Stewart Ford alleged that the FSA’s interference of Keydata’s business finally caused its collapse, and applied for judicial review of the FSA’s investigations on the basis that it had sought to rely on the contents of legally privileged emails as evidence in the FSA’s enforcement proceedings against Mr Ford.

The FSA obtained access to Mr Ford’s emails which were covered by privilege, from Keydata’s administrators, PriceWaterhouseCoopers who had been nominated by the FSA. The privileged emails (together with attachments) in question were communications between Mr Ford and the legal advisors that were appointed by him to advise Keydata and its executives (including Mr Ford) on the FSA investigations. The administrators also waived Keydata’s legal privilege in respect of the contents of the documents.

In this regard, Mr Ford was neither informed of the fact that his email account was being accessed and copied, nor was he consulted on the waiver of legal privilege.

Held:

Mr Justice Burnett decided that as a result of joint legal professional privilege in respect of the communications between Mr Ford and his lawyers, the FSA could not rely on the contents of those communications in the regulatory proceedings.

(R (on the application of Stewart Ford) v Financial Services Authority & Ors [2011] EWHC 2583 (Admin))

Contact:  xiaohanguo@city-law.net

The UK Government has, nearly a year ahead of the prescribed timetable, taken steps to introduce two important changes to UK law, which became effective on 31 July 2011. When an issuer looks to raise additional capital, two questions always arise, namely whether a Prospectus will be required and secondly, if the answer is “no”, will the fundraising document require approval by an authorised person as a Financial Promotion, or will the issuer be exempt form obtaining such approval.

The changes to UK law are to amend two triggers which determine whether a Prospectus is required for a particular fundraising:

• Number of potential investors to whom an offer may be made before the requirement for a Prospectus is triggered has been increased from 100 to 150; and
• the de minimis amount which may be offered by an issuer in any twelve month period has been increased from €2.5 million to €5 million without triggering the requirement for a Prospectus.

Companies seeking to raise capital in other EU states should bear in mind that the UK Government has implemented the changes ahead of time, so it is possible that the existing thresholds remain unchanged.

Assuming however that a Prospectus will not be required in certain scenarios, an issuer will also need to consider whether the proposed fundraising document requires approval as a Financial Promotion or whether it can be exempt under the Financial Promotion regime.

Contact: ritapadam@city-law.net

In January 2010 the FSA sent “Dear CEO letters” to relevant financial groups asking for checks to be undertaken to ensure that firms understood and were fully compliant with the rules set out in its Client Asset Sourcebook (“CASS”).

Towry responded to the letter saying that it was fully compliant. However, Towry failed to ensure the response was properly considered before submitting it to the FSA. The reality was that the firm was not compliant and this only became apparent after the FSA visited the firm in November 2010 and discovered the breaches.

Towry’s failure to provide an accurate response to the FSA was a breach of Principle 11 of the FSA’s handbook, which requires firms to deal with the FSA in an open and cooperative manner. The failure of the firm to treat client money in the correct way breached Principle 10.

According to the FSA Towry’s failings were particularly serious for the following reasons:

• Dear CEO letters are an important regulatory tool used by the FSA to raise significant issues and firms must consider them with particular care;
• Towry failed to ensure the response to the Dear CEO letter was properly considered and checked before being sent, resulting in inaccurate information being provided to the FSA;
• Towry’s CASS breaches could have placed clients’ money at risk of potential loss or delay in distribution if the firm had become insolvent because it failed to maintain adequate records;
• Towry failed to identify the breaches itself. Instead, the matters came to the FSA’s attention during an FSA visit to the firm in November 2010; and
• There has been a high level of awareness in the financial services industry of the importance of handling client money properly since the collapse of Lehman Brothers on 15 September 2008 and failure to do so is not acceptable.

Tracey McDermott, acting FSA director of enforcement and financial crime, said “accurate communication with the FSA is of fundamental importance”.

She also noted that “it should go without saying that taking steps to ensure information provided to us is properly considered, up to date and correct is a basic regulatory requirement.” The FSA sounded a warning bell to other firms that they “should be in no doubt about how seriously we regard such failures.”

contact: colincarroll@city-law.net

Background

The Appellant (M) was incorporated in Luxembourg but is part of a wider group of companies providing telecommunications.

On 17 November 2005 M entered into a sale and purchase agreement with the respondent (N) pursuant to which M agreed to acquire a 51% interest in T from N for US$150million. At the time it was understood that T indirectly owned through (subsidiaries) B.

On 22 November M and N entered into a put and call option agreement for the remaining 49% of the shares in T for $170million.

M alleged that on 15 December 2005 B’s corporate offices were seized by a third party causing M to effectively lose control of it. In November 2006 N exercised the put option.

The Arbitration

In January 2007 N commenced arbitration proceedings in London against M under the London Court of International Arbitration rules seeking (amongst other things) specific performance of the put option. M contested the proceedings. The Tribunal delivered its award in November 2010 in favour of N (in the Court of Appeal it was assumed the amount of the Award was $208 million). M did not challenge the Award, which became final on 5 January 2011.

The Commercial Court Proceedings

On 26 January 2011 N applied to the Commercial Court without notice to M for registration of the award as a judgment pursuant to section 66(2) of the Arbitration Act 1996 and for a worldwide freezing order against M. The application to register the award as a judgment was granted.

The Court also granted a freezing order until 4 February when the parties were to come back before the Court. M was restrained from disposing of, dealing with or diminishing the value of any of its assets whether inside England or Wales or not, up to $208 million. The freezing order contained the usual exception that M was not prohibited from dealing or disposing of its assets in the ordinary and proper course of business.

As part of a fund raising exercise M’s parent MTS made an issue of $400 million 8% Notes due 2012. Interest was paid twice yearly in arrears (on 28 January and 28 July). The proceeds of the issue were on-lent by M to MTS pursuant to a back-to-back inter-company Loan Agreement dated 28 January 2005. Under the Loan Agreement MTS was to pay interest to M two business days before 28 January and 28 July each year. M was then obliged to deposit with the Paying Agent by 27 January and 27 July the funds required to pay the interest to the noteholders. The notes were publicly listed and traded on the Luxembourg Stock Exchange.

On 2 February 2011 M made an urgent application to the court for a declaration that the interest due on 28 January 2011 could be paid. The Court held that it could for two reasons (i) the payment had already been made to the Paying Agent before the freezing order was granted and (ii) it was within the ordinary course of business.

At the return date of 4 February N applied to have the ordinary course of business exception removed from the Order. This application was granted.

In the meantime M applied to set aside the order granting leave to enforce the Award as a judgment and relief to enable a tender offer in respect of the Notes to take place. This was granted on 18 February, although the freezing order was continued.

On 4 July 2011 M sought a variation of the freezing order to allow the payment of interest to noteholders on 28 July. It was common ground that the payment of interest could properly be characterised as being in the ordinary course of business (although that exception had been removed on 4 February). The Court refused to vary the freezing order. M appealed.

The Court of Appeal

The Court discussed the case law in relation to post judgment freezing orders, noting the ordinary course of business exception may be removed where there would be no disruption to a judgment debtor’s business. In this case although N had an unchallenged award did not mean that M should for all purposes be treated as a judgment debtor. If there was a judgment of the Court it was presently unenforceable pursuant to the order of 18 February. Although the freezing order could be said to be granted in aid of execution since execution was presently unavailable, it was not a remedy designed to effect execution.

The question the Court had to answer was whether a “judgment debtor” against whom the judgment debt is presently unenforceable be prevented from meeting its obligation that fall within the ordinary course of business? Having reviewed the authorities the Court held that a freezing order granted in aid of an arbitration award should generally contain an ordinary course of business exception.

On the facts the payment of the interest to noteholders would not amount to a dissipation of assets with the object of denying N satisfaction of its claim. Nor would it be a payment made to avoid execution since execution was presently unavailable. M was seeking to meet an obligation that had fallen due in the ordinary course of business.

(Mobile Telesystems Finance SA v. Nomihold Securities Inc [2011] EWCA Civ 1040)

Contact: clarkhood@city-law.net