© 2015 Winston & Strawn London LLP Corporate and Business Law Update London Calling SPRING 2015 In This Issue: UK government relaxes the rules restricting the words used in company names ..........................................................2 UK challenge to EU banker bonus cap rejected.........................................................................................................................2 Earn-out calculations must follow the requirements set out in the purchase agreement.............................................3 Agreement to negotiate in good faith within a limited period held enforceable..............................................................4 Listing Rules: FCA fines Reckitt Benckiser £539,800 for listing and disclosure rule failures ......................................5 “Upside fee” under a financing agreement not an unlawful penalty....................................................................................6 Schemes of arrangement and payment of stamp duty land tax (SDLT) ..............................................................................6 Diverted Profits Tax...............................................................................................................................................................................7 Key Contacts Zoë Ashcroft Partner, Corporate and Finance Practice + 44 (0) 207 011 8725 firstname.lastname@example.org Nicholas Usher Partner, Corporate and Finance Practice + 44 (0) 207 011 8734 email@example.com 2 Corporate and Business Law Update – London Calling © 2015 Winston & Strawn London LLP UK government relaxes the rules restricting the words used in company names New regulations have recently come into effect which have resulted in the lifting of the restriction of the use of certain words in company names. The regulations will apply to all companies and limited liability partnerships (LLP) who seek to change their names, or any application to register a new company or LLP name. The regulations The Company, Limited Liability Partnership and Business Names (Sensitive Words and Expressions) Regulations 2014 and the Company, Limited Liability Partnership & Business (Names and Trading Disclosures) Regulations 2015 came into force on 31 January 2015, reducing the list of sensitive words and expressions which companies, LLPs and businesses need approval to use in their name. The Regulations were introduced as part of the UK government’s “Red Tape Challenge” which aimed to simplify the overall regulatory framework in the UK. Key changes • The list of “sensitive words” has been reduced, so that words such as “national”, “European”, “international”, “United Kingdom”, “group” and “holding” are now allowed to be used in a company name without the need for prior approval. • The list of “same as” names has been reduced. The words which can now be disregarded when considering whether a proposed name is the “same as” an existing name include “export”, “group”, “holding”, “international”, and “services”. • The list of characters, accents and symbols that can be used in a company name has been extended. • If at least six companies share an office, place or location, their registered names no longer have to be displayed at all times at the location and may be held and made available for inspection instead. Effect of the changes The changes have been welcomed by business groups who consider that the changes will make the company formation process smoother and quicker by giving startups more scope and flexibility in their choice of name. The reduction in the list of sensitive names for example will ease the administrative burden on companies who previously needed to seek Government approval to use such terms in their name. This was a particular problem for large, world-wide, companies looking to use words such as “United Kingdom”, “group” and “holding” in a UK company’s name. UK challenge to EU banker bonus cap rejected EU bonus cap On 1 January 2014, a cap on bankers’ bonuses came into effect for certain employees at EU-based banks (which includes their subsidiaries and branches located outside the EU). The EU cap restricts bonuses to 100% of banker’s fixed pay or 200% with the approval of shareholders. Shareholder approval is met if at least 66% of members owning at least 50% of total shares are in favour. If the members voting represent fewer than half of the total shares, then a 75% threshold must be reached. The bonus cap will apply to the remuneration of senior management, material risk-takers (MRTs), staff engaged in control functions and any employee whose total remuneration is in the senior management/MRT range. Although the bonus cap rules came into effect on 1 January 2014, the cap applies to remuneration for services and performance from 2014 onwards so, it will be this year’s bonus round which will be caught by the changes. Allowance payments Several banks have already made changes to remuneration structures in an attempt to sidestep the rules by making “role-based” allowance payments. These payments are classified by the banks as fixed-pay but unlike salaries can be adjusted up or down each year. Under EU law, remuneration must either be classified as variable and part of a bonus, or fixed. If the payments are considered to be fixed as salaries, they would lead to an increase in salary levels and in turn increase the limit of the cap, weaken the link between reward and performance and make the industry less flexible in a downturn. If categorised as variable and part of a bonus, the amount would be subject to the two times annual salary cap. The EU watchdog, the European Banking Authority (EBA), has said that such allowance payments breached its guidance as the majority of the role-based allowances are being wrongly classified as fixed pay. In order for a rolebased allowance payment to be considered as fixed pay, it must be permanent for that specific job, pre-determined, non-discretionary, non-revocable and transparent to all staff. 3 Corporate and Business Law Update – London Calling © 2015 Winston & Strawn London LLP UK legal challenge The UK Government started a legal challenge to the bonus cap with the European Court of Justice (ECJ) but withdrew late last year after Niilo Jääskinen, the ECJ Advocate General, rejected all six arguments made by the UK against both the scope and legal basis for the new rules. These arguments included that the EU did not have the right to limit pay in a member state, however, Jääskinen gave an opinion that the EU legislation limiting the ratio was valid. He said: “fixing the ratio of variable remuneration to basic salaries does not equate to a ‛cap on bankers bonuses’, or fixing the level of pay, because there is no limit imposed on the basic salaries that the bonuses are pegged against.” The UK Government claims that this is precisely the point that undermines the entire rationale of the new rules. If bonus levels are linked to a multiple of annual salaries then as salaries are not capped, any cap on bonuses is artificial. The UK Government also argued that the cap would drive talent out of Europe and inflate basic pay, making it harder for banks to cut costs in a downturn leading to a more unstable banking system. Current status The EU now wants to introduce fixed rules by the end of 2015 with all EU states then having to apply them to bonuses paid from early 2016. The EBA and EU have opened a three month consultation period on formalising these draft rules, which ends on 4 June 2015. The Prudential Regulation Authority which is charged with enforcing the rules or explaining to the EU why British banks are not complying with them, urged banks to study the consultation carefully and respond to the EBA. Earn-out calculations must follow the requirements set out in the purchase agreement An earn-out is a mechanism which can be used in an acquisition to determine part or all of the purchase price and is based on the future performance of the target business. The Court of Appeal’s decision in Treatt plc v Barratt and others  EWCA Civ 116 addressed the validity of an earn-out notice served under a share purchase agreement (SPA). The Court found that a notice setting out the buyer’s calculation of the earn-out consideration due under the SPA was not valid as the buyer had failed to comply with the requirements of the agreement when calculating the earn-out specified in the notice. Buyer’s who decide to alter the financial year of a target company post-acquisition should take particular note of the decisions. Treatt plc v Barratt and others The earn-out under the SPA was to be calculated by reference to the pre-tax profits of the target companies as shown in their audited accounts for two previous calendar years ending 31 December. It was for the buyer to calculate the initial amount of the earn-out and to provide notice of this to the seller. After completion, the buyer changed the accounting reference date of the target companies to 30 September to align with its own financial year-end. As such, the audited accounts for the years ending 31 December were not available at the time of the calculation of the earn-out. The buyer decided to make the calculation based on the audited consolidated accounts for the buyer’s group with the year-end of 30 September, and from management accounts for the target companies for the three months between September and December for the relevant years. The calculation of the earn-out notice was not disputed by the sellers using the dispute resolution procedure in the SPA and so the buyer claimed that the sellers were bound by the calculation of the earn-out as set out in the notice. The earn-out was defined in the SPA as an amount calculated in accordance with the contractual formula and by reference to those audited accounts identified in the definition. Decision The Court of Appeal held that the judge at first instance had been right in stating that a notice which did not adopt the basis identified in the earn-out definition was not an earn-out notice for the purposes of the SPA and that the requirement for the earn-out to be calculated by reference to the specified audited accounts was a form of contractual protection of real importance to the sellers rather than a mere formality. The Court held that an earn-out notice would not be invalidated by some accidental mathematical error in calculation where the calculation was based on relevant accounts. Such issues were part of what the procedure specified in the SPA for expert determination was designed to address. 4 Corporate and Business Law Update – London Calling © 2015 Winston & Strawn London LLP Conclusion The case discussed above is a useful reminder of the need for accuracy and the importance of both the drafting of and compliance with the contractual provisions for the service of earn-out notices in share purchase agreements. It also highlights the importance of ensuring that the conditions for earn-out calculations are practical and capable of being met even where changes occur post-completion. This decision suggests that the courts will take a strict approach to the reading of such provisions, and that they will not be concerned with different interpretations to the relevant contractual obligations, even where made in good faith. Agreement to negotiate in good faith within a limited period held enforceable Emirates Trading Agency v. Prime Minerals Parties to a contract will typically agree upon a particular method of dispute resolution. Some parties implement simple dispute resolution clauses, electing for either litigation or arbitration, while others build in alternative methods of dispute resolution which either permit or require the parties to escalate the dispute, such as via informal or formal negotiations followed by a formal mediation, before embarking upon arbitration or litigation. Generally, a clause in a contract which requires the parties to attempt to resolve a dispute or claim ‘in good faith’ will not, by itself, be enforceable. An obligation to negotiate is generally regarded as so uncertain so as to render it impossible to perform and so the court has no objective criteria to enable it to decide whether a breach has occurred. However, the recent High Court case of Emirates Trading Agency LLC v. Prime Mineral Exports Private Limited demonstrates that where an agreement to negotiate in an escalation clause is defined sufficiently clearly, it may be enforceable in the event one party tries to depart from the agreed escalation process. Facts of the case Emirates Trading and Prime Mineral entered into a longterm contract for the sale and purchase of iron ore. A dispute arose that resulted in Prime Mineral terminating the contract and claiming damages from Emirates Trading. Prime Mineral then commenced arbitration proceedings in accordance with the dispute resolution clause in the contract. The dispute resolution clause provided: “In case of any dispute or claim arising out of or in connection with or under this [Agreement] ... the Parties shall first seek to resolve the dispute or claim by friendly discussion. Any Party may notify the other Party of its desire to enter into [consultation] to resolve a dispute or claim. If no solution can be arrived at between the Parties for a continuous period of 4 (four) weeks then the nondefaulting party can invoke the arbitration clause and refer the disputes to arbitration.” Upon the commencement of arbitration proceedings, Emirates Trading petitioned the Court for an order that the arbitral tribunal lacked jurisdiction because Prime Mineral had failed to engage in "friendly discussions" before commencing the arbitration proceedings. The Court was, therefore, tasked with determining whether the dispute resolution clause and, in particular, the apparent obligation on the parties to "... resolve the dispute or claim by friendly discussion" was enforceable. Enforceability of dispute resolution clause The Court considered the relevant English law authorities on agreements to negotiate and the enforceability of agreements to settle disputes by means of ADR. In general English law does not recognise an agreement to negotiate on the grounds that such agreements are too uncertain to enforce. The House of Lords, in Walford v Miles, held that an agreement to negotiate lacked the necessary certainty and was therefore unenforceable. The Court distinguished Walford v Miles on the basis that it was not a case involving a dispute resolution clause within a binding contract requiring the parties to seek a settlement within a limited period of time. Conclusion The Court concluded that it was not bound by authority to hold that a dispute resolution clause, in an existing and enforceable contract which requires the parties to seek to resolve a dispute by friendly discussions in good faith and within a limited period of time before the dispute may be referred to arbitration, is unenforceable. The Court accordingly found that the agreement in this case was enforceable for the following reasons: • The agreement was not incomplete, no term was missing; and • The agreement was not uncertain; an obligation to seek to resolve a dispute by friendly discussions has an identifiable standard of fair, honest and genuine discussions aimed at resolving the dispute. 5 Corporate and Business Law Update – London Calling © 2015 Winston & Strawn London LLP The Court held, on the facts, that the parties did engage in friendly discussions in good faith to seek to resolve the claim and that the arbitration was not commenced until after a period of four continuous weeks had elapsed. On that basis, the condition precedent to arbitration was satisfied. Corporate Finance Listing Rules: FCA fines Reckitt Benckiser £539,800 for listing and disclosure rule failures Overview The Financial Conduct Authority (FCA) has imposed a financial penalty on Reckitt Benckiser Group plc (RB) of £539,800 for maintaining inadequate systems and controls to monitor share dealing in RB shares by its senior executives. These failures, which occurred over a number of years, resulted in late and incomplete disclosure of share dealings by two senior executives to the market. However, there was no suggestion that the senior executives traded on the basis of inside information or deliberately breached the Model Code. Insufficiencies in RB’s systems and controls between July 2005 and October 2012 were combined with inadequate records and training of its senior executives and other persons discharging managerial responsibilities (PDMRs) and meant that RB was unable to properly monitor share dealings made on behalf of its PDMRs by third parties. When RB became aware of the share dealing by its senior executives, it should have notified the market by the end of the next business day but it failed to do so. RB agreed to settle with the FCA at an early stage of the investigation. RB therefore qualified for a 30% (stage 1) discount under the FCA’s procedures. Without the discount the FCA would have imposed a fine of £771,190. The dealings The FCA’s fine related to dealings by two of RB’s PDMRs. The first involved the use of shares by a PDMR (PDMR A) as security for a credit facility extended to him. PDMR A was unaware of the fact that using his shares as security constituted dealing under the Model Code. The second involved a sale of RB shares by a PDMR (PDMR B), which had been held in the name of a private foundation in an off-shore account. PDMR B claimed that he had sought and received oral clearance from RB to proceed with the transactions. RB had no record of this, and so verification was not possible. PDMR B then failed to notify RB of the dealings. When RB became aware of the dealings it immediately notified the UKLA but failed to notify the market within the time required by the Disclosure and Transparent Rules (DTR). When RB did notify the market of the dealings by PDMR A and PDMR B, the notifications did not contain all of the information required by DTR 3. FCA Findings The FCA took the view that RB failed to comply with Listing Rule 9.2.8 – that a listed company must require its PDMRs to comply with the Model Code and must require them to take all proper and reasonable steps to secure their compliance. The FCA stated that it is “reasonable to expect a listed company to take proactive steps to comply with LR9.2.8R and to have in place procedures, systems and controls that serve to facilitate and encourage the compliance of its PDMRs with the Model Code which enable the company to identify and deal promptly with instances of non-compliance.” The FCA also found that PDMRs were able to deal without prior clearance and RB did not on any formal or regular basis emphasise or provide training on the importance of compliance with the Model Code. RB was also found to have breached Listing Principles 1 and 2 and DTR 3.1.4 and 3.1.5 in respect of the inadequate notifications to the market. Recommendations for listed companies The decision is significant in that the FCA has stated that it expects all listed companies to learn the lessons from this case and to ensure they proactively put in place and maintain the right controls and training in place. To ensure compliance with the regulations, listed companies should therefore: • clearly identify who are their PDMRs; • make sure that their directors and other PDMRs receive adequate and periodic training on their obligations under DTR 3 and the Model Code. Issuing reminders in advance of close periods and conducting an annual self-certification process will not alone be sufficient for these purposes; • ensure that the clearance to deal procedures set out in the company’s share dealing policy are followed and formally documented; • regularly review the PDMR share dealing policy and mitigate any risks; • consider putting procedures in place with the company’s registrars so that any movements in the 6 Corporate and Business Law Update – London Calling © 2015 Winston & Strawn London LLP shareholdings of PDMRs can be monitored in real time; and • where PDMRs hold shares other than in their own names, consider requiring those PDMRs to provide contact details for the relevant nominee or custodian and arrange for the company secretary to receive notifications of any changes in the shareholdings in addition to a copy of the month end statement provided to the PDMR. Finance “Upside fee” under a financing agreement not an unlawful penalty In the recent case of Edgeworth Capital (Luxembourg) S.A.R.L and another v Ramblas Investments B.V  EWHC 150 (Comm) (Edgeworth Capital), the High Court decided that the rule against penalties did not apply to an “upside fee” clause in an upside financing agreement between a lender and borrower which provided that, “in consideration of the bank procuring the availability of and arranging and negotiating the terms of the facility” for one of the corporate borrowers, the borrower agreed to pay a fee to the bank when there occurred a “payment event”. This case serves as a useful reminder that careful drafting of provisions that provide for payments in circumstances not amounting to breach of contract can mean that the rule against penalties does not apply. In this case, it meant that an upside financing fee of approximately €105 million was deemed commercially justifiable and enforceable, in the context of a transaction that involved loans in an aggregate value of over €1.5 billion. Was the upside fee triggered? Edgeworth argued that a “payment event” had occurred because the borrower “in effect” defaulted under a related loan agreement with the bank and that such default constituted a cross-default triggering an obligation to pay the upside fee under the upside financing agreement. The judge found as a matter of interpretation and on the facts, that the obligation to pay the upside fee was indeed triggered. Was the upside fee a penalty clause? The judge then examined whether the upside fee was subject to the rule against penalty clauses. The rule provides that if a payment provision in a contract constitutes an unlawful penalty and not a genuine preestimate of loss for breach, the Court will not enforce such clause. The High Court concluded that the rule did not apply on two main grounds. Firstly, the event that triggered the upside fee did not increase the borrower's overall obligation and, secondly, the upside fee clause was not triggered by a breach of duty by the borrower to the lender. Under the terms of the upside financing agreement, the upside fee was payable in various circumstances, not just in the event of breach. Moreover, the fee was payable to the lender at some point and the effect of the triggering event was only to bring forward the time for payment. For example, if a related junior loan agreement had been repaid at the end of its term, the fee would have been due, and there could have been no suggestion at that point that it was a penalty. The judge noted that it would be “perverse if [the borrower] was somehow placed in a more advantageous position by breaching rather than performing the junior loan”. The second limb of the judge’s reasoning was that the rule against penalties would apply only if the operation of the fee clause had been triggered by a breach of duty owed by the party that claimed relief from the penalty, in this case the defendant. In the present circumstances however, the default was a default by related individual borrowers under a separate agreement, which in turn had triggered the application of the fee clause under the upside financing agreement. The judge underscored the fact that this was a case of two separate contractual arrangements, involving different contracting parties. The fact that another party (the claimants) may be the counterparty to both contracts “made no difference”. Finally, even if the above grounds were not present and even though the upside fee clause was not a genuine pre-estimate of loss for breach, the purpose of the upside fee clause was commercially justifiable. Its main purpose was not to deter the borrower from breach, but to compensate the lenders for what was effectively a bridging loan in challenging commercial circumstances and so not regarded as an improper penalty. Tax Schemes of arrangement and payment of stamp duty land tax (SDLT) There has been an increasing number of public company takeovers structured as schemes of arrangement. A key advantage of using a scheme of arrangement has been that it is possible to structure the takeover in a way that 7 Corporate and Business Law Update – London Calling © 2015 Winston & Strawn London LLP avoids SDLT. Whereas SDLT is payable on the transfer of shares in UK companies (though not AIM companies) at a rate of 0.5%, the issue of new shares is not subject to SDLT. It has been possible to save SDLT on a public company takeover by reducing the target company’s share capital and issuing new shares to the bidder under a court-approved scheme. The UK Government at the end of last year said that it would introduce amendments to section 641 of the Companies Act, which sets out the circumstances in which a company may reduce its share capital, to prohibit reduction schemes in order to protect the stamp tax base. These amendments were considered by the House of Common’s Second Delegated Legislation Committee on 23 February 2015, where they were shown considerable support, with the general consensus that it was appropriate that there is fair treatment of taxation, no matter how a takeover is structured. On 4 March 2015, the Companies Act 2006 (Amendment of Part 17) Regulations 2015 were published and came into effect as of the same date. This does not mean that a scheme of arrangement will not continue to have some advantages over the more traditional ‘offer’ route as a means of structuring a public company takeover. In particular, a scheme of arrangement is a popular method of takeover partly because of the more easily achievable level of target shareholder support than compared with a tender offer process. Diverted Profits Tax With effect from 1st April 2015, a new UK tax will be introduced. This new tax known as the “diverted profits tax” (DPT) will be charged at the rate of 25% on the amount of profits deemed to have been diverted from the UK. The DPT is limited in its range but is a considerably higher tax rate than that of UK corporation tax (currently charged at 21% for large companies). DPT applies only to large multinational enterprises and will be aimed at two sets of circumstances; • avoiding permanent establishment (PE) the legislation will operate to impose the DPT on an overseas entity which has substantial UK activities but has deliberately avoided establishing a UK taxable presence. The new tax will be calculated by reference to a “just and reasonable” allocation of profits in respect of UK activities (subject to certain exceptions) but will not apply where the group wide revenue from UK sales is less than £10 million; and • arrangements lacking economic substance – in this case the DPT will (subject to certain exceptions) operate to counteract “contrived arrangements” entered into by UK companies or UK PE’s with related parties, that exploit tax differentials and lack economic substance. In a departure from standard procedure, the DPT is based upon an estimated amount assessed by the UK tax authority (HMRC) and payable within 30 days of notice being given to the taxpayer. There is then a 12 month review period during which the DPT assessment may be adjusted based upon evidence, and following this period the taxpayer may appeal to the courts against the DPT charge. There is no postponement of disputed DPT during the review period or due to any subsequent appeal. Large enterprises who operate in the UK through limited risk distributor arrangements, are UK based and use holding companies for intangible property based in low tax jurisdictions, or who have entered into arrangements with affiliates based in low tax jurisdictions, are among those who are likely targets for the DPT and they may consider it prudent to expedite the gathering of documentation and evidence to defend against the imposition of a DPT charge or to minimise any DPT assessment.