UK: Corporate Briefing - June 2011

Last Updated: 26 June 2011
Article by Simon Gamblin

The law and regulation affecting businesses in the UK continue rapidly to develop and present companies with opportunities and challenges.

In this Corporate Briefing, we cover a wide range of new developments. Highlights include:

  • welcome new tax incentives to encourage entrepreneurial investment by individuals and companies in high-tech industries; and
  • helpful guidance about compliance with the Bribery Act 2010 for businesses generally and for the insurance market in particular.

Private sector growth is the Government's stated top priority and it is good to see it taking measures to promote growth, both through the tax system and by seeking to allay fears that the new bribery legislation will put UK businesses at a competitive disadvantage.

In creating the conditions for growth, the Government has emphasised cutting the burden of regulatory red tape. We look forward to the Government achieving its objective, so that we can report meaningful reductions in regulation, as well as doing our best to keep you informed of relevant new law and regulation.

New tax incentives for investors

By Ray Smith and Zoe Hammond

In the 2011 Budget (delivered on 23 March) the Government announced a number of important tax measures designed to encourage UK resident individuals to become "entrepreneurs" and invest in higher-risk unquoted trading companies and companies operating in the life science and bio-tech sector.

The measures increase the levels of tax relief for investors, and widen the eligibility criteria for investee companies. The measures will be provided for in the Finance Act 2011 (the first draft of which was published on 31 March 2011) and the Finance Act 2012.

Subject to EU State Aid approval, individual investors will now be entitled to 30 per cent income tax relief (an increase from 20 per cent) in respect of the amount they invest into enterprise investment schemes (EIS). From 6 April 2012, investors can invest up to £1 million per tax year into EIS (the previous limit was £500,000) and both EIS and venture capital trust (VCT) relief will be available for companies with up to 250 employees (increased from 50), with gross assets of not more than £15 million, and which are seeking to raise £10 million (increased from the previous limit of £2 million) of capital in a 12-month period. However, companies operating in the renewables sector claiming "Feed-in Tariffs" will now be excluded from companies qualifying for VCT/EIS relief.

The Government also announced, as part of a wider package of encouraging entrepreneurial investment, an increase to the lifetime limit for capital gains that qualify for "entrepreneurs'" relief (which, subject to certain conditions being satisfied, results in an effective capital gains tax rate of 10 per cent) to £10 million (from £5 million) for disposals of qualifying shares on or after 6 April 2011. This was coupled with the usual increase (to £10,600) of an individual's annual exemption from capital gains.

For companies operating in the life science and bio-tech sector, the rate of research and development tax credits for small and medium enterprises will be increased to 200 per cent from April 2011 and 225 per cent from April 2012.

In summary, the new measures are good news for UK individual investors and for UK businesses in general. The measures were also, in part, a pleasant surprise and welcome relief. As the tax rates applicable to capital gains (28 per cent or 10 per cent where entrepreneurs' relief is available) are considerably lower than income tax rates (40 per cent for higher rate and 50 per cent for additional rate taxpayers), there was a real concern prior to the Budget (particularly given the Government's urgent need to cut the budget deficit as quickly as possible) that the Government might move towards aligning capital gains tax and income tax rates. Fortunately, the Government resisted this temptation and instead introduced changes that demonstrate that it is committed to trying to kick-start the economy through private sector investment and investment in high-tech industries

When is a company insolvent?

By Mark Everett

A new judgment of the Court of Appeal has made more complex and subjective the determination of whether a company is insolvent by reason of the so-called balance sheet test in section 123(2) Insolvency Act 1986.

Although the case concerned a structured finance, asset-backed, transaction, the Court's detailed consideration of the balance sheet test is of considerable general interest.

Definition of insolvency

If a company is insolvent (ie, unable to pay its debts), it not only runs the risk that it may be wound up by the court under section 122 Insolvency Act 1986 (the IA), it may also trigger an event of default in key contracts such as financing agreements.

Typically, such events of default refer to the definitions of inability to pay debts in section 123 IA, in particular the test of a company's inability to pay debts as they fall due in section 123(1)(e) and the so-called balance sheet test in section 123(2) which provides that:

"A company is also deemed unable to pay its debts if it is proved ... that the value of the company's assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities."

Taken at face value, the balance sheet test might be taken to mean that a company is deemed to be unable to pay its debts, whenever it has negative net assets.

For the first time, in BNY Corporate Trustee Services Limited v Eurosail-UK-2007-3BL plc & others (2011), the Court of Appeal has considered in detail the meaning of section 123(2).

Eurosail

In June 2007, Eurosail had acquired a portfolio of sub-prime UK mortgage-backed loans, funded by the issue of different classes of interest bearing notes, denominated in sterling, US dollars and euros. As the mortgages were redeemed, the proceeds were used to pay off the notes in a stipulated order of priority. The long stop date of redemption for the outstanding notes was 2045. To hedge its exposure to interest and exchange rate fluctuations, Eurosail took out swap contracts with a Lehmans entity, which were terminated when Lehmans failed.

The sterling received by Eurosail, when mortgages were redeemed, was only sufficient to repay a smaller quantum of dollar and euro denominated notes than was originally envisaged. This resulted in a significant deficiency in Eurosail's net assets. One class of noteholders argued that an event of default had occurred, because the company's liabilities exceeded its assets within the meaning of section 123(2), to which the relevant event of default referred.

Court's interpretation of balance sheet test

The Court rejected outright the proposition that a company can be balance sheet insolvent, simply because its "liabilities (however assessed) exceed its assets (however assessed)". So, if the balance sheet test is not a mechanistic one, how does it work? The Master of the Rolls said that it "can only be relied on by a future or contingent creditor of a company which has reached "the end of the road", or in respect of which the shutters should be "put up", imprecise, judgment-based and fact-specific as such a test may be".

In the case of Eurosail, the Court found that it had not reached the "point of no return". The Court was being asked to look a long time into the future, the principal under the outstanding notes was not finally due to be repaid until 2045 and the weighted average term of the remaining mortgages was 18 years, with early redemption rates slowing. Eurosail was not "on any commercial view, insolvent".

Implications of Eurosail

Fact specific as it clearly is, Eurosail nevertheless gives an important pointer as to how courts are likely to regard attempts to base insolvency on the balance sheet test in section 123(2). Taking assets and liabilities at face value as they appear in the accounts will not be enough. The company must also be shown to be "at the point of no return". This is not to say that there is no longer a balance sheet test for insolvency, though it now looks harder to establish. It is clear that the outcome in Eurosail could well have been different had the terms of the mortgages been shorter and/or the redemption date of the notes been sooner.

The degree of uncertainty which Eurosail engenders means that any party to a contract that contains an event of default by reference to section 123 IA will need to consider very carefully before seeking to exercise its rights on the basis of the balance sheet test of insolvency.

At the time of writing, it is not known whether permission will be granted for an appeal to the Supreme Court.

The much-delayed Bribery Act 2010 (the Act) will finally come into force on 1 July 2011, having received Royal Assent as long ago as April 2010. Guidance concerning the Act has now been issued, both generally and specifically for the insurance market.

Bribery Act – general and insurance market guidance

By Stephen Browning and Simon Gamblin

The much-delayed Bribery Act 2010 (the Act) will finally come into force on 1 July 2011, having received Royal Assent as long ago as April 2010. Guidance concerning the Act has now been issued, both generally and specifically for the insurance market.

In summary, the Act replaces the previous common and statute law by creating four offences:

  • bribing another person;

  • being bribed;

  • bribery of a foreign public official; and

  • the new corporate offence of a company's failure to prevent a bribe being paid on its behalf in the UK or elsewhere by a person with whom it is associated (which term includes employees and agents), subject to a defence of "adequate procedures" being in place to prevent a bribe.

Guidance concerning the Act has been issued by the Ministry of Justice (MoJ), the Serious Fraud Office (SFO) and the Director of Public Prosecutions (DPP). The guidance is intended to allay fears that the Act is a trap for the unwary, which could too easily result in strict liability for the bribery activities of a company's agents (including those outside the UK) and the criminalisation of everyday corporate activities, such as routine client entertainment.

The MoJ guidance helpfully makes clear that, in relation to having "adequate procedures" in place to prevent bribery, a company's procedures are expected to be proportionate to the risks that it faces and to the nature, scale and complexity of the organisation's activities. This is to be welcomed as recognising that, for example, small UK organisations are very unlikely to need such extensive procedures as multi-nationals. Nevertheless, it remains the case that where an associated person has committed a bribery offence, the burden of proof is on the company to show that it had adequate procedures in place, so all companies will wish to be able to point to a well-considered and proportionate anti-bribery policy.

The MoJ guidance also makes clear that it is not the Government's intention to criminalise reasonable and proportionate corporate hospitality expenditure. For such expenditure to be caught, the prosecution would need to show that the hospitality was intended as a bribe and this would be judged by the objective standard of a reasonable person in the UK. Clearly, all companies should have in place appropriate corporate gifts and hospitality policies.

The SFO and DPP guidance makes clear that prosecutions will only proceed if a case passes both the evidential stage and the public interest stage. Regarding the latter, factors in favour of prosecution would be:

  • conviction would be likely to attract a significant sentence;

  • the offence is pre-meditated and may involve corruption of the person being bribed; or

  • the offence is committed to facilitate more serious offending.

Factors against prosecution would be:

  • the court is only likely to impose a minor penalty;

  • the harm was minor and the result of a single incident; or

  • there was a genuine proactive approach including self-reporting and remedial action.

The guidance is to be welcomed, particularly that a risk-based and proportionate approach can be taken to preventing bribery. However, Justice Secretary Kenneth Clarke's characteristically breezy assertion that "bribery is one of those things we all know when we see it" leaves companies having to exercise their own discretion in respect of conduct that appears to be prohibited under the Act, but to which the guidance suggests that a blind eye may be turned.

Implications for the insurance sector

The insurance sector has of course been addressing anti-bribery issues for some time before the Act. Firms regulated by the FSA are expected to have anti-bribery controls in place. There is the overriding principle that firms must conduct their business with integrity (PRIN 2.1.1). Specifically, a firm's senior management is responsible for taking reasonable steps to prevent financial crime risks (including bribery) from crystallising (FSA Handbook, SYSC 3.2.6R).

The FSA has also given anti-bribery guidance to the insurance broking community in May 2010. Whilst the report is primarily concerned with the commercial brokerage market, it is also relevant to insurers and reinsurers and contains many examples of what the FSA considers to be good and bad practice in relation to anti-bribery and anti-corruption systems and controls.

Insurance market participants incorporated in the UK will be subject to the Act, as will non-UK companies if they participate in an act of bribery that involves a UK element. Non-UK companies, if they carry on business or part of a business in the UK, will be at risk of prosecution for the corporate offence if bribery is committed anywhere in the world on their behalf.

In relation to the corporate offence, it is worth bearing in mind that a company's associated person would have to be shown beyond reasonable doubt to have bribed another person with the intention of obtaining or retaining business or an advantage in the conduct of business for that company. A discussion between employees over placing an insurer's risk with a reinsurer might take place at a corporate hospitality event arranged by the insurer's employee, and the risk might subsequently be placed with the reinsurer. An offence may potentially have been committed only if it was the intention of the employee that the placement of the risk would be accepted because of the hospitality and not for a proper reason (such as that the risk was acceptable on its merits and its acceptance would be commercially remunerated).

In short, the new guidance makes clear that, like other business sectors, insurance market participants are not, as a result of the Act, at greater risk of prosecution in respect of their normal commercial behaviour. Bribery has always been unlawful and the MoJ is encouraging a common sense approach to concerns about the breadth of the Act. It will though be of even greater importance for companies to be able to point to well-documented and publicised policies and procedures on areas such as corporate hospitality and gifts.

On 17 May 2011, Lloyd's issued Market Bulletin Ref: Y4492 to update managing agents on the implementation of the Act and to give guidance on the key points that managing agents may need to review.

The guidance advises managing agents to review their relationships to determine who may be their associated persons for the purposes of the Act. These could include:

  • employees;

  • subsidiaries;

  • coverholders;

  • brokers acting on their behalf;

  • third party loss adjusters;

  • external advisors;

  • joint venture parties; or

  • other third party service providers

In addition to brief sections on corporate hospitality and facilitation payments, the Lloyd's guidance contains more detailed analysis of the position of coverholders and brokers. It recommends appropriate due diligence procedures and the use of anti-bribery terms and conditions in contracts between managing agents and their coverholders and brokers, where the latter are acting on behalf of the managing agents rather than the insured. Of course, where a broker is not an associated person of the managing agent, it is still necessary for the managing agent to consider whether any payment arrangements with the broker would constitute bribery under the Act.

Regarding commissions, the guidance states that Lloyd's is of the view that (i) payment of normal commission, generally paid to a broker (including as coverholder) out of the premium payable by its client, should not constitute an offence under the Act, provided it is reasonable and commensurate with the work involved, and (ii) other forms of remuneration paid by insurers to insurance intermediaries need to be considered on a case by case basis to check that they do not fall foul of the Act.

Lloyd's is engaged in a series of workstreams in relation to the Act, including:

  • publishing guidance for coverholders;

  • adding a financial crime binding authority clause to the standard binding authority wording (LMA 3019) to serve, inter alia, as an anti-bribery warranty with which coverholders must comply;

  • extending the scope of the coverholder audit to include compliance with the Act; and

  • writing to all Lloyd's accredited brokers asking them to confirm their compliance with the Act.

In addition, the LMA and IUA are reviewing the model TOBA wordings and, if considered appropriate, will publish an addendum in relation to financial crime prevention by 1 July 2011.

Lloyd's recommends that where there are any uncertainties arising from, inter alia, risk reviews, new business arrangements or relationships with, or remuneration payments to, third parties, managing agents should seek legal advice.

The IUA and LIIBA have also issued to their members guidance concerning the Act. Members can obtain copies of the guidance from the associations

Assessing investment suitability

By Rupert Connell and By Adam Blair

On 21 March 2011, the FSA published its finalised guidance on assessing suitability of investments (FG11/5).

The guidance is in response to a consultation which took place in January 2011 and also to the FSA's ongoing findings that certain firms' investment selections failed to account for risks a customer is willing and able to take.

The perceived high number of unsuitable investment selections, in the pensions and investments markets in particular, constitutes a "significant concern" for the FSA (2011/2012 Retail Conduct Risk Outlook). The guidance is therefore aimed at firms that provide investment advice or discretionary management services to retail customers, but is also relevant to providers of risk-profiling and asset-allocation tools (including those provided as part of a platform).

The guidance relates to chapter 9.2 of the Conduct of Business sourcebook (COBS), which deals with how firms ought to assess the risks that clients can, or wish to, undertake and on making a suitable investment selection. For example, COBS 9.2.1R requires a firm to take reasonable steps to ensure that a personal recommendation, or decision to trade, is suitable for its client. COBS 9.2.2R requires firms, among other things, to take account of a client's preferences regarding risk taking, their risk profile and the purposes of the investment.

In drafting the guidance, the FSA focused on the fitness of the various methodologies used for assessing customers' willingness and ability to take risks with their money, descriptions that firms attach to different categories in the investment – risk spectrum and the process for choosing investments. (The full guidance can be accessed here.) In summary, firms should in particular ensure that:

  • they have a robust process for assessing the risk a customer is willing and able to take, including:

– assessing a customer's capacity for loss;

– identifying customers that are best suited to placing their money in cash deposits because they are
unwilling or unable to accept the risk of loss of capital; and

– appropriately interpreting customer responses to questions and not attributing inappropriate weight to
certain answers;

  • tools, where used, are fit for purpose and any limitations recognised and mitigated;
  • any questions and answers that are used to establish the risk a customer is willing and able to take, and descriptions used to check this, are fair, clear and not misleading;
  • they have a robust and flexible process for ensuring investment selections are suitable given a customer's investment objectives and financial situation (including the risk they are willing and able to take, as well as their knowledge and experience);
  • they understand the nature and risks of products or assets selected for customers; and
  • they engage customers in a suitability assessment process (including risk-profiling) which acts in the best interests of those customers.

Whilst the FSA does not prescribe how firms establish the risk a customer is willing and able to take, or how they make investment selections, it nevertheless expects firms to consider whether they need to improve the way they assess suitability. Further, the FSA has warned that, as part of its intensive supervisory approach, it will look to see how firms have acted on the guidance. They will, in particular, be looking at whether firms have robust procedures, tools and risk category descriptions (where used) to establish and check the level of risk a customer is willing and able to take.

Corporate manslaughter – Court of Appeal upholds first conviction under the Corporate Homicide Act 2007

By Suhani Evans

Under section 1 of the Corporate Homicide Act 2007, which came into force in April 2008, an organisation is guilty of corporate manslaughter if the way in which it manages or organises its activities causes a person's death and amounts to a gross breach of a relevant duty of care owed by the organisation to the deceased.

For an organisation to be found guilty of this offence, a substantial element of the breach must have been in the way that its senior management managed or organised its activities.

On 15 February 2011, Cotswold Geotechnical Holdings (the Company) became the first company to be convicted of the new offence of corporate manslaughter under the Corporate Homicide Act 2007 (the CHA). The Company was fairly small with only eight employees, so it was relatively easy for the prosecution to identify senior management and their role within the Company for the purposes of satisfying section 1 of the CHA.

The prosecution arose because a geologist employed by the Company died from asphyxiation when, in breach of industry guidance, he was working alone in an unsupported 3.5 metre pit which collapsed. The jury found that the Company's system of work in digging pits was wholly and unnecessarily dangerous and that it had been in gross breach of its duty of care in failing to comply with industry and health and safety guidance.

In deciding the penalty, the court took into account the size of the Company and its financial state. Field J noted that the Company was in a "parlous" financial state, but still fined it £385,000, payable over ten years. No additional order for the payment of the prosecution's costs (£140,000) was made, although the judge indicated that this would have been ordered, had the Company been in a better financial state. In his judgment, Field J stated that such a fine could put the Company into liquidation and result in job losses. However, he said that, whilst this would be unfortunate, it was unavoidable as it was a "consequence of the serious breach".

On 12 May 2011, the Court of Appeal rejected the Company's appeal against its conviction and upheld the fine.

The Crown Prosecution Service has indicated that it is reviewing other cases for possible prosecution under the CHA. It is therefore essential for employers to ensure that they have in place appropriate safety and risk assessment procedures which are regularly reviewed

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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