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NOVEMBER 2008

With lenders trying every device to maximise their income, it is worth thinking about your facilities and what the future might hold.

Existing Loans and Overdrafts
The renegotiation of loans and overdrafts has been getting more difficult for some time, with lenders seeking increased margins, additional security and reductions in their exposure. One common gambit is to propose that the interest on a loan or overdraft facility should be based on a margin over LIBOR (the London Inter-Bank Offered Rate), rather than bank base rate. LIBOR is quoted for overnight rates, 3 month rates and 12 month rates. All of these rates have one thing in common: they are traditionally between .01 and 1.3 per cent above base rate, a fact that lenders may fail to highlight.

Future Loans and Overdrafts
It is not uncommon for a verbal agreement regarding the ability to draw down additional funds to be countermanded, so it is unwise to rely on anything which is not formally contracted in writing. In addition, if the lender becomes insolvent, all bets could be off regarding extensions of loans or facilities.

Other Facilities
The same logic applies to revolving facilities, such as stocking loans and factoring arrangements. The big downside here is that the reduction or withdrawal of funding may be sudden, leaving the business little time to make alternative arrangements – an outcome which may be catastrophic. It makes sense to review the terms of any revolving finance as a matter of urgency and to consider the possibility that access to it may be cut.

As a general rule, it is also now more risky to breach a banking covenant, as this may provide the lender with an excuse to review your agreement with it, to your disadvantage.



General

‘Loser Pays’ Limitations
It has long been a principle of English law (unlike the law in some countries, most notably the USA) that in litigation the loser pays their costs and those of the winner.

However, this principle has been diluted over the years and a recent court decision has spelled out the approach the courts may be expected to take when awarding costs in cases in which a number of issues are argued.

The basic idea is that the court will look at the entirety of the behaviour of any litigant, in particular regarding failures to make an offer to settle or a refusal to negotiate with the other side. In such cases, a cost ‘penalty’ may well result, especially if the costs are allowed to become large when compared with the value of the claim.

The main principles are as follows:

• Where each party claims that the net position is that payment is due to it, the winner will normally be the party which receives payment;
• The court should take as its starting point the general rule that the successful party in litigation is entitled to an order for costs;
• Having considered the above, the judge must then consider, having regard to all the circumstances of the case, what changes may be justified;
• If possible, the judge should reflect the relative success of the parties on different issues by making an order for costs which is proportionate to this and which takes account of the cost of arguing each issue;
• The judge will have to take account of any offers made to settle the litigation as well as each party's approach to negotiations and the general conduct of the litigation;
• If a nearly sufficient offer is made to settle the matter which is rejected outright by the other party, then it might be appropriate to penalise the second party when awarding costs; and
• In assessing a proportionate costs order the judge should consider what costs are common to several issues. Normally, the winner will be able to recover not only the costs specific to the issues which he has won, but also the common costs.

The courts are keen to see disputes settled without taking up court time where this is possible. When an intransigent attitude is taken by one of the parties, adverse costs consequences can result.

Effective and experienced representation will help to make sure that any legal disputes you may have are settled to your satisfaction as quickly as possible and without negative cost consequences.

Can’t Get Paid by A? Try B!
One of the less well-known ways in which a business or person who is owed money by someone who fails to pay can obtain payment is by the use of a Third Party Debt Order (TPDO). In essence, this is a court order which requires someone (B) who owes money to another (A) to pay you instead, when A owes a debt to you. Usually, B is a bank or building society.

A TPDO can be applied for at any time after you have obtained judgment against A in court. An order will not be made unless A has failed to pay the amount of the judgment when it was due or has failed to pay one or more of the instalments due under the terms of the judgment.

The application for a TPDO is examined by the court and, if granted, you and B will be sent a notice. A week later, the notice is sent to A. This stops A from being able to circumvent the order by moving cash out of an account before the order is put into effect.

Once notice of the order has been served on B, it serves to freeze money held on A’s account on the day the notice is received by B. So, for example, if the order is received by B on Tuesday, money paid into the account on Wednesday will not be frozen. This makes the planning of the timing of service important. In a recent case, a TPDO application failed because the claimant was unable to prove that B owed a debt to A.

At a later date, a hearing is held to confirm that the money frozen is to be paid to you.

If B is not a bank or a building society, they must let you and the court know within seven days if they claim not to owe A any money or to owe less than the sum claimed. If you wish to dispute this, you must file your written evidence with the court not less than 3 days before the hearing.

If B is a bank or building society, it will supply information regarding the accounts held by A and will confirm that the sum it holds on A’s account is sufficient to pay the sum due or advise the balance if not. It will also advise if it is entitled to retain any sum to offset A’s liabilities to B.

A can file an objection to the order not less than 3 days before the hearing is due to take place. The objection must be in writing and A must send you a copy. The judge will hear A’s objections at the hearing. If A is an individual, rather than a business, and can prove that he and his family are suffering hardship in not being able to meet day to day living expenses as a result of an amount or amounts being frozen, then a hardship payment order may be made which will ‘unfreeze’ some of the frozen money. Where A is a business, it must prove that real prejudice would be suffered by not having access to the money.

TPDOs will not normally be issued where A has become insolvent.



Property

Lords Provide Rent Review Relief for Landlords
Landlords will breathe a sigh of relief following the recent reversal of the decision in the much-reported case of Scottish and Newcastle v Raguz. It dealt with the requirement on landlords to serve notices on each outstanding payment date during the rent review process in order to have the right to collect the increased rent payable.

The decision that this is not required not only reduces the administrative burden on landlords, but also removes the risk that they may suffer loss through a relatively trivial administrative oversight.

Be Careful What You Say!
A case involving a dispute over the tenancy under various leases of industrial units in East Sussex, which were used for the preparation of airline meals, illustrates the importance of being careful what you say.

Although the circumstances were rather convoluted, the nub of the issue was that due to planning issues surrounding the smell created by the tenant’s business, it was unclear whether the tenant would be able to remain in occupation of the buildings.

Although the tenant wished to remain where it was, it claimed to have sent to the landlord notices to terminate the leases. The landlord claimed not to have received them. The tenant also sought out alternative premises, which it let on a weekly basis, in case the planning decision went against it.

The tenant claimed that the landlord had agreed verbally to grant three-year leases on some of the units. The landlord claimed no such agreement was reached.

Reviewing the contemporaneous evidence, such as correspondence and board minutes, the court was able to conclude that the three-year leases had been created.

In this instance, there was copious supporting documentation, which is by no means always the case. One point that is clear is that if documents are being created on which it may be necessary to rely, it is important to send these to the other party to the negotiation in a form which confirms they have been delivered.



Tax

VAT Input Tax and Exempt Supplies – Back to the Table
For businesses which make both taxable and exempt supplies for VAT, there is a need to apportion the VAT they pay (input tax) between that relating to their taxable supplies and that relating to their exempt supplies, as the latter cannot be reclaimed as input tax. The publicly stated position of HM Revenue and Customs (HMRC) is that all the input tax will normally be ‘blocked’ (i.e. not recoverable) and it is up to the VAT registered trader to justify that the method for calculating the input tax recovered is ‘fair and reasonable’ given the particular circumstances.

This can be very difficult to do, as deciding whether a particular expense relates to the taxable or non-taxable supplies can be almost impossible. In practice, a proportion is agreed between the taxpayer and HMRC. There are ‘industry standards’ which can be applied in some cases.

In a recent VAT Tribunal case heard in Scotland, Lombard, a subsidiary of the Royal Bank of Scotland, sought to increase the amount of input tax it could claim from 15 per cent (the industry standard) to 50 per cent. Its argument was based on the point that in a normal leasing transaction it makes two supplies, one of which is taxable and one of which is exempt. Since VAT law, rather than accounting necessity, creates the concept of an exempt transaction, Lombard had no means of arriving at a precise apportionment. HMRC had proposed no alternative basis for performing the calculation.

The Tribunal agreed that in the circumstances, reclaiming 50 per cent of the input VAT was fair. HMRC appealed to the Court of Session, which was swift to order the matter back to the negotiating table. The Tribunal had not explained why it held 50 per cent to be a reasonable proportion, nor had it explained why the method proposed by Lombard was considered to be fair and reasonable.

So, the matter will now have to be negotiated afresh. However, it does raise the issue for partially-exempt traders as to whether they should look again at the basis under which they calculate their recoverable proportion of input tax to see if a larger percentage recovery might be justifiable.



Company Law

Time to Rethink D&O?
Many companies are unaware of or have considered and rejected the idea of director and officer (D&O) insurance, but past experience indicates that along with liquidity problems, companies and their directors face a heightened risk of litigation during economic downturns.

The usual purpose of D&O insurance is to cover the threat to directors and senior managers that their personal assets will be at risk in the event of litigation. Normally, the company will write a policy to indemnify its officers, and D&O insurance is normally written as an ‘add on’, to cover risks not dealt with by the company’s policy, or as ‘top-up’ cover to it.

There are types of activity that significantly increase the risk to directors. For example, raising capital by way of share issue or by the issue of public debt is particularly risky. Actions by employees and shareholders are also a risk in some circumstances. The Companies Act 2006 has posed additional obligations on company directors as well.

In the present environment, it is likely that investors, creditors, employees and customers will be quick to act when they see things going wrong. Now is a good time to undertake a comprehensive review of your existing D&O insurance coverage, to review the precise terms attaching to any commercial finance or debenture agreements and to consider the protection offered by your contract of service.

Is My Company Deposit Account Safe?
With new stories of bank instability featuring regularly in the newspapers, the Government’s decision to raise the amount of deposit that it will guarantee in the event of bank failure to £50,000 was welcomed by all. However, it has not been made clear if the guarantee under the Financial Services Compensation Scheme (FSCS) applies only to individuals or whether it includes company deposits as well.

The FSCS protects the deposits of small companies, which are those which meet two of three criteria:

• they have fewer than 50 employees;
• their turnover is not more than £6.5 million per year; and
• the balance sheet total is less than £3.26 million.

The £50,000 limit is also available for unincorporated organisations, partnerships and sole traders, but in the latter case the limit would apply in total to all (i.e. business and personal) accounts held by the customer with the same lender.

One possible area for concern is whether deposits held in different members of the same banking group are covered separately. In this case, if each of the banks is separately authorised by the Financial Services Authority, the FSCS would pay compensation up to the limit of £50,000 per person, per authorised institution. If each of the banks is not separately authorised but is covered by the parent company's authorisation, the FSCS would pay compensation up to the limit of £50,000 once, irrespective of with how many different group members a person held accounts.

Deposit takers in the Channels Islands and Isle of Man are not covered by the scheme.

Intellectual Property

A Dispute in the Making?
A recent case contains a number of messages for businesses entering into contracts with others to exploit intellectual property, perhaps the main one of which is to watch out who you go into business with.

The case involved a man who invented an improved latch for car doors. In 2001, his company entered into an agreement with Honeywell, a company which makes parts for cars.

He was unsatisfied with the progress Honeywell made with regard to making a commercially viable model and in 2003 he ended the joint collaboration agreement between his company and Honeywell. His company then commenced proceedings against Honeywell for the profits that would have been earned from the successful commercial exploitation of the latch.

Many breaches of the contract by Honeywell were alleged, but mainly these related to design changes, which were alleged to be unauthorised, and failure to devote enough resources to the project. The court found as a matter of fact that whilst there had been breaches in the past, any problems had been resolved before the action was commenced and that there were no existing breaches of contract by Honeywell when it was commenced.

Although the claimant was extremely well prepared (a bundle of 360 pages of documents was presented in evidence), the judge found that the main cause of the action was the personal antipathy the inventor had for members of the Honeywell management team. Furthermore, the £600 million claim, which was based on the loss of the chance to profit from his invention, was described as ‘so speculative that no damages would be recoverable on the basis of the loss of a chance’. The judge summed up by saying that there was a strong element of the ‘Walter Mitty’ about the claimant. Additionally, a claim based on past breaches which had been rectified could not be justified.

Lastly, and most amazingly of all, the method by which any profits from the exploitation of the design would be split between Honeywell and the claimant had not in any event been agreed.

In this case, it is surprising that warning bells weren’t ringing earlier. Firstly, inventors have a reputation for being an idiosyncratic breed and for being problematic to deal with: it must have been evident that the relationship between the inventor and Honeywell was in difficulty. Having the skill to form an accurate judgment about the people you are dealing with is important – the relationship between the parties to a contract is often a crucial factor in determining whether disputes can be resolved amicably or not. It can be easy to let one’s enthusiasm for a product cause insufficient attention to be paid to the practicalities of working with the other party to the contract. It looks as though this case was a problem waiting to happen. Secondly, it is very important to get any contractual documentation in place early in the proceedings, in particular as regards the split of income arising from the exploitation of the invention.

Court of Appeal Rules on Patent for Computer Program
The Court of Appeal has now heard the appeal in Symbian Ltd. v Comptroller of Patents, an important intellectual property (IP) case as it deals with the question of whether or not a computer program can be patented under the European Patent Convention 1973 (EPC).

Symbian had applied for a patent for a computer program it had written and the application had been refused by the Comptroller General of Patents. The patent was for a novel way of accessing a dynamic link library (.dll) file in a computing device. These files are used to store common functions that are used in a number of different programs. When they are modified, they can become incompatible with some of the programs which use them and the patent concerned a way of overcoming this problem. This in turn would make a variety of devices work more quickly and reliably.

Symbian argued that a program which provided a technical solution to a technical problem was capable of being patented. The Comptroller General of Patents argued that patent law prohibited the granting of a patent on any program, unless the program had a novel effect outside the computer.

The Court of Appeal decided that a staged approach had to be taken to decide whether a computer program could be patented or not. The first step was to make sure the claim was properly construed, then to identify the contribution made by the program and then to identify whether the function of the program fell wholly within the exclusions in the EPC. If so, it could not be patented. If not, the program could be considered for patent.

In the case in question, a computer with the software would be a more efficient and reliable computer. In addition, other devices would benefit from the invention. The solution proposed was a technical solution and was innovative.

The application to deny the patent was therefore refused.

Patent law can be complex, particularly where a patent for a computer application is being sought.

Contract

When Pressure Doesn’t Pay
It is often thought that anything goes when negotiating contracts or varying them, but the court will not enforce a contract that has been entered into under economic duress. Economic duress occurs when there is illegitimate compulsion, the practical effect of which is such that it denies one party to the contract any practical choice and is a significant cause of it entering into the contract.

Recently, a case was heard in which the argument of economic duress was made to the court by motor manufacturers, which used a firm to make plastic units for a van. When they wished to restyle the van, the manufacturer of the units was unable to make them in the new style required, so was given six months’ notice of termination of its contract.

The supplier of the units then demanded compensation for termination and a price increase for the units supplied in the final period of the contract, threatening to cease supply if these demands were not met. The effect of a cessation of supply would have been to stop the van manufacturers’ production lines, which would have had severe economic effects. They therefore accepted the demands, but went to court to seek repayment of the excess sums demanded plus interest.

The court accepted the argument that economic duress was applied, rendering the contracts void. It awarded compensation to the motor manufacturers.

The courts are inclined to come down hard on those who use economic blackmail.

Is Arbitration History?
A recent case has called into question the inherent fairness of arbitration clauses used in agreements between businesses and consumers, unless consumers are properly advised on the legal effect of such clauses.

The case concerned (predictably) a dispute between a homeowner and a builder. The builder’s work was undertaken using a standard form contract which included an arbitration clause.

Under the contract, in the event of a dispute an arbitrator was to be appointed and the arbitrator’s decision was to be final. The impact of this was not explained to the homeowner before she signed the contract, which in any event did not include a mechanism for the appointment of the arbitrator. In such cases, the appointment should be agreed by both parties. Following the dispute, the homeowner refused to participate in arbitration, so the builder appointed the arbitrator alone.

The arbitrator made an award against the homeowner and she went to court to contest it – and won.

The judge ruled that because the arbitration clauses were not fully explained to the homeowner, they were invalid, because they created an imbalance of rights between the supplier and customer which breached consumer law, specifically the Unfair Terms in Consumer Contracts Regulations 1999. The appointment of the arbitrator was therefore invalid, as was his decision.

It remains to be seen how much impact this decision will have on other similar cases, as the implication is that where such contracts specify the appointment of an arbitrator, the arbitrator’s appointment would appear to be automatically unfair unless appropriate advice has been given.

It is good practice in any event to advise members of the public who are offered a contract to take legal advice regarding its implications before signing it and to evidence this advice in writing.

Insolvency

Pre-Pack Rule Book Given Thumbs-Up
The proposed set of rules for ‘pre-pack’ administrations (where a company goes into administration with the prospective purchaser already in place and the sale effectively a ‘done deal’) has been given the thumbs-up by insolvency practitioners.

The main advantage of a pre-pack is that the company in difficulty can continue to trade without interruption. It is argued that this allows the best price to be realised for the company. It is also argued that it allows the administrator to avoid many expenses that would normally be incurred during the period in which a buyer is sought, thereby reducing the risk to other creditors of receiving a smaller dividend. In addition, pre-packs are claimed to reduce the likelihood that the business will be put into liquidation.

However, pre-packs have a number of opponents, including HM Revenue and Customs (HMRC), which often face a shortfall in VAT, Corporation Tax and/or PAYE when a company enters administration. HMRC have opposed a number of pre-packs in court, with varying success. A more recent alleged tactic involves the denial of VAT Registration Numbers to companies engaged in setting up a pre-pack.

The rule book will go some way to ensuring that pre-packs are dealt with in a consistent and ethical way.



Data Protection

Database Extraction Clarified
The European Court of Justice has confirmed in a recent ruling that for the purposes of ascertaining whether a database owner’s rights have been infringed by ‘extraction’ of database information, extraction is not confined to the physical copying of the data in the database.

The decision of the Court was that the decisive criterion was an act of transfer, for which purpose it was immaterial whether the transfer was effected by electronic, electromagnetic or electro-optical means or by a simple manual process. Accordingly, the transfer of a sample of the information in a database, after an on-screen consultation and an individual assessment of the material contained therein, was capable of constituting an extraction.

Therefore, if a database is accessed and information taken from it selectively (as opposed to the whole of the database being copied), this is still an infringement.



Employment Law

Age Discrimination and Enhanced Redundancy Pay Schemes
Under the Employment Equality (Age) Regulations 2006, discrimination on age grounds can sometimes be justified. The statutory redundancy scheme is based on age and length of service but is exempted, by Section 33 of the Regulations, from being discriminatory. However, an employer’s own enhanced redundancy pay scheme is only exempt if it mirrors the statutory scheme, applying the same multiplier to all aspects of it – see Section 33(3) of the Regulations – or if it can be objectively justified as a ‘proportionate means of achieving a legitimate aim’, such as rewarding loyalty or providing assistance to older employers who might find it harder to find another job.

Employers with a contractual redundancy pay scheme should review it to ensure that it does not discriminate or that they can justify that its terms are a proportionate means of achieving a legitimate aim.

Age Discrimination and Job Advertisements
Although many businesses are contemplating downsizing, owing to the worsening economic situation, if you are recruiting staff, it is important to remember that the Employment Equality (Age) Regulations 2006 make it unlawful to discriminate on grounds of age, including when advertising to fill a vacancy.

The case of Rainbow v Milton Keynes Council illustrates the danger to employers, when placing a job advertisement, of specifying the number of years’ experience required by applicants as this can be indirectly discriminatory. In some instances, this will be because potential candidates may have the necessary skills required for the job but be too young to have gained the qualifying length of experience or, as was the case here, because they are of an age where they are likely to have more years’ experience than stipulated in the advertisement.

Ms Rainbow, aged 61, had 34 years’ teaching experience and was therefore on a higher pay scale than a younger teacher. In October 2006, a full-time post became available at the school where she worked part-time. The job advertisement said that the post would suit ‘candidates in the first five years of their career’. Ms Rainbow applied for the post but was not short-listed for interview. She was told that the school wished to appoint someone on the same pay scale as the teacher who was leaving.

The Employment Tribunal (ET) found that the school had indirectly discriminated against Ms Rainbow because of her age. It had applied a practice that put her at a disadvantage, as someone over 60 is likely to have more than five years’ experience, and had provided no real evidence to justify the discrimination. The Council had sought to justify the practice on cost grounds, citing as its reason the financial constraints under which the school operated. However, it did not produce compelling evidence to show that it was forced to take the discriminatory action. For example, it had not investigated alternative cost saving measures.

The ET held that if an employer wishes to rely on cost as a factor when justifying discriminatory treatment, it should not be the sole factor.

Employers are advised to take extreme care when drafting job advertisements. It is important to focus on the requirements of the post and the type of experience necessary to fulfil the role. Apply these criteria when short-listing candidates and keep a record to show that decisions have been reached on an objective basis. It is unlikely that cost alone will be sufficient reason to justify an indirectly discriminatory practice.

Health and Safety

Accident Cover-Up Means Jail for Director
A Director who was injured in a workplace explosion in which one of his company employees was killed has seen his company fined £60,000 and he has been sent to prison, following his attempt at a cover-up of the circumstances surrounding the tragedy.

The death occurred when gas cylinders were being processed for scrap and an acetylene cylinder, which was not empty, exploded, causing a fireball that engulfed the director and the employee, who later died in hospital.

When being prosecuted for various health and safety offences, the director changed his plea to guilty in the witness box and was sentenced to three years in prison for attempting to pervert the course of justice. He was also fined £1,000. He was acquitted on a charge of manslaughter.

The Health and Safety Executive (HSE) has announced that over the next six months it will be targeting scrap yards and waste-metal recycling plants.

The HSE has considerable powers and is not afraid to use them, particularly in cases such as this where very dangerous practices were undertaken and the risk to employees and others was high. Attempting to conceal the true facts behind a fatality is unwise in the extreme.

Health and Safety – Increased Penalties Loom
The Health and Safety (Offences) Act 2008 received Royal Assent on 16 October 2008 and will come into force in January 2009. It amends Section 33 of the Health and Safety at Work etc. Act 1974 and will increase penalties for breaches of health and safety legislation and provide the courts with greater sentencing powers for those who flout health and safety law.

The Act raises the maximum penalty that can be imposed in the lower courts for breaching health and safety regulations from £5,000 to £20,000 and the range of offences for which an individual can be imprisoned has also been broadened.

The changes are intended to allow more health and safety prosecutions to be dealt with in the lower courts and also to make the threat of imprisonment a reality for more blameworthy offences.



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