On 20 April 2016, the UK’s Supreme Court issued its judgment in the case of Asset Land Investment Plc and another v the Financial Conduct Authority. The case was an appeal against the decision of the Court of Appeal that Asset Land Investment Plc’s (“Asset Land”) land investment scheme amounted to a collective investment scheme (“CIS”) within the meaning of section 235 of the Financial Services and Markets Act 2000 (“FSMA”). The case clarifies the CIS definition.

Background

Asset Land acquired three sites in Surrey during 2006 and 2007, which it sub-divided into plots for sale to investors. During that period roughly 300-400 investors bought plots at those sites. Asset Land subsequently acquired other sites around the UK and marketed them for sale in much the same way.

The offering to investors was that Asset Land would petition the local planning authorities for the sites to be re-zoned for residential development. Once the land had been re-zoned, Asset Land would procure the sale of the land to a developer, with the owner of each plot receiving a proportionate share in the proceeds of the sale.

The Financial Services Authority (the predecessor to the Financial Conduct Authority, which this note will refer to together as the “FCA”) became aware of this scheme in early 2007 and entered into discussions with Asset Land on the basis that its offering constituted a CIS under FSMA. Initially Asset Land agreed with the FCA that it would cease to represent itself as responsible for seeking re-zoning of the land and arranging a sale to a developer. However in June 2011, after forming the view that Asset Land was not observing the agreed restrictions on its activities and was operating an unregulated CIS without the requisite permission under Part IV of FSMA, the FCA appointed investigators over Asset Land’s business. This judgment is the culmination of the subsequent litigation between the FCA regarding Asset Land’s activities.

Legislative requirements

Establishing, operating or winding up a CIS is a regulated activity in the UK. FSMA provides that authorisation is required from the FCA to lawfully carry on a regulated activity by way of business in the UK, except for persons who are exempt from the requirement to be authorised. Carrying on unlawful regulated activities is a criminal offence.

“Collective investment scheme” is defined under section 235 of FSMA. In summary, a CIS is any arrangements with respect to property of any description, the purpose or effect of which is to enable persons taking part in the arrangements to receive a financial return from the scheme property. The participants in the scheme must not have day-to-day control over the management of the property, and the scheme must also have either or both of the following characteristics:

  1. pooling of the contributions of the participants or the income from which payments are to be made to participants; and/or
  2. management of the property as a whole by or on behalf of the operator of the scheme.

Judgments of the Supreme Court

The Supreme Court upheld the Court of Appeal’s view that the Asset Land scheme constituted a CIS. The leading judgment was issued by Lord Carnwath, and was unanimously supported by the other four sitting law lords. A further judgment was issued by Lord Sumption who, while agreeing with Lord Carnwath’s judgment, wished to further clarify some elements of the CIS definition, which he described as “one of the more problematic features of the United Kingdom’s system of statutory investor protection”. Those elements of the CIS definition which the judgments seek to clarify are what amounts to “arrangements”, “day-to-day control” and “management of the property as a whole”.

“Arrangements”

Both Lord Carnwath and Lord Sumption held that the Asset Land scheme amounted to “arrangements” within the meaning of section 235 of FSMA. In particular, Lord Sumption commented that “arrangements” is a broad term that comprises any understanding shared between the parties to the transactions about how the scheme would operate, whether legally binding or not. The term also includes consequences which flow from the understanding between the parties, or from the commercial context in which it was made.

As such, the Court held that the arrangements between Asset Land and the investors were the mutual understanding between the two parties based on the representations of Asset Land’s salesmen, i.e.  that Asset Land would procure the re-zoning and subsequent sale of the sites, with the investors receiving a share of the sale proceeds. It was in the Court’s view immaterial that this was not reflected in the legal documentation of the scheme.

This decision confirms that the concept of “arrangements” concerns the substance of arrangements and not their form, i.e. the courts will give effect to what the parties intended the arrangements to achieve rather than simply what the relevant legal documents provide. A key point is that it is what the parties objectively intended at the outset of the arrangements that is the crucial factor, and not what later happened (if different to the original understanding).

“Day-to-day control”

Lord Sumption stated that “control” of property means the ability to decide what happens to it, which does not only encompass the legal ability to decide but extends to a case where the investor will in practice be able to do so. The absence of day-to-day control has to be a feature of the arrangements, viewed from the time when the arrangements were made, with the question being who would exercise control of the property were such control to be required.

In the case of Asset Land, Lord Sumption’s view was that it was hard to conceive how an individual investor could ever have day-to-day control of any more than his individual plot, and that section 235 of FSMA must therefore refer to the control exercisable by the investors collectively. The Asset Land investors did not have control over the whole site, either individually or collectively, meaning control of the scheme property rested with Asset Land.

This is a helpful clarification of what constitutes “control” over the management of the property of a CIS. Providers of schemes which have the potential to amount to CIS should ensure when establishing their schemes that investors have genuine day-to-day control over the management of the scheme property so as to avoid falling within this element of section 235.

“Management of the property as a whole”

In considering what constitutes “management activity”, Lord Sumption drew a fundamental distinction between two types of arrangements:

  • the first type being where the investor retains entire control of the property and employs a service provider to operate it; and
  • the second type being where investors surrender control over their property to the operator of a scheme so that it can be pooled or managed in common, in return for a share of the profits generated by the collective arrangements.

This distinction was in Lord Sumption’s view necessary if there is to be a workable distinction between CIS and cases where an intermediary provides services without assuming control over the assets within the scheme.

Lord Sumption considered Asset Land’s role in finding a buyer for the site was an act of management if the arrangements empowered Asset Land to effect a sale on the investors’ behalf, rather than simply putting a proposal for sale before investors to approve or reject as they saw fit. Conversely, Asset Land’s role in finding a buyer was not an act of management if it was simply expected to put a proposal before the investors to approve or reject at their discretion. Lord Sumption held that in practice the arrangements between Asset Land and investors amounted to a CIS. While in theory investors had complete control over the ownership of their plots, in reality that control was merely an illusion as the scheme could not work if the investors exercised their right to sell their plot independently of Asset Land. In what appears to be a general statement on this point, Lord Sumption stated that he considered selling or procuring the sale of an asset to be an act of management.

The Court’s approach indicates that where the investors in a scheme retain control over their investments and employ a service provider in respect of those investments, the scheme property will not be “managed as a whole by or on behalf of the operator of the scheme”, and the scheme will in consequence not be a CIS. Whether this will in fact be the case in practice will however need to be considered on a case-by-case basis.

Comment

This case is the first time that the Supreme Court or its predecessor, the House of Lords, has considered the interpretation of the definition of “collective investment scheme” in s.235 of FSMA. It is clear from the ruling that the Court will look behind any contractual documentation to examine the true nature of the relationship between the investors and investment provider in determining whether a CIS exists, rather than simply looking at the contractual position. This includes any representations made by sales representatives which induce potential investors to become investors in the scheme, even where those representations are not reflected in the legal documents entered into by the scheme provider and investors.

This is in keeping with Lord Sumption’s general statement that it is important when construing a regulatory statute such as FSMA not to allow technical distinctions to frustrate the purpose of the legislation. The FCA has long taken this approach in relation to CIS, looking at how a scheme operates in practice rather than how its legal terms state it should operate.

It is interesting in this regard to note that Lord Carnwath explicitly approved the FCA’s position under Q6 of section 11.2 of its Perimeter Guidance Manual. Q6 states that, in relation to the day-to-day control test, if the substance of the arrangements is that each investor is investing in property whose management is under his control, the arrangements should not be regarded as a CIS. If the substance is that each investor obtains rights under a scheme which provides for someone else to manage the property, the arrangements would be regarded as a CIS. Lord Carnwath considered that this “draws the correct contrast” in respect of what constitutes “day-to-day control” for the purposes of section 235.

This case can therefore be seen as adding to and in large part affirming the existing approach to what constitutes a CIS while adding additional clarity to certain key concepts.

It should be noted in closing that while the judgments of the Court are of help in clarifying aspects of the definition of a CIS, whether a given set of arrangements will amount to a CIS needs to be the subject of considered assessment, taking into account the unique facts and circumstances of each case.