The latter half of 2016 was dominated by all things Brexit but there were several other interesting legal developments last year, particularly in relation to the use of electronic signatures; changes to the Companies Act 2006 that have a potential impact on share security; and the evolution of the application of the EU Bank Recovery and Resolution Directive. In this briefing we look back at those developments and at what is coming up in 2017 and beyond.
Many businesses are now opting to sign documents using electronic signatures to allow the signing process to be conducted remotely and making use of e-signing platforms. There were a number of legal developments relating to e-signatures in 2016:
in July, the Law Society and the City of London Law Society issued a practice note on the execution of documents governed by English law using electronic signatures (the Practice Note, available here)
BANKING YEAR REVIEW 2016 AND WHAT IS ON THE HORIZON IN 2017 AND BEYOND The latter half of 2016 was dominated by all things Brexit but there were several other interesting legal developments last year, particularly in relation to the use of electronic signatures; changes to the Companies Act 2006 that have a potential impact on share security; and the evolution of the application of the EU Bank Recovery and Resolution Directive. In this briefing we look back at those developments and at what is coming up in 2017 and beyond. Electronic Signatures Many businesses are now opting to sign documents using electronic signatures to allow the signing process to be conducted remotely and making use of e-signing platforms. There were a number of legal developments relating to e-signatures in 2016: • in July, the Law Society and the City of London Law Society issued a practice note on the execution of documents governed by English law using electronic signatures (the Practice Note, available here) • also in July, EU law on electronic signatures was amended by a directly applicable regulation on electronic identification (EU Regulation 910/2014, known as the eIDAS Regulation) with consequential amendments made to English law • then in August updated guidance on electronic signatures and trust services was published by the Department for Business, Energy & Industrial Strategy. JANUARY 2017 London Table of Contents Electronic Signatures 1 Introduction of various changes to the Companies Act 2006 by the Small Business, Enterprise and Employment Act 2015 (SBEE Act) 2 Brexit 3 EU Bank Recovery and Resolution Directive 2014/59 (BRRD) – Article 55 – Contractual Recognition of Bailin Requirement 4 Ban on Big Four Auditor clauses 5 Financial Collateral 5 European Commission proposals for new rules to determine law applicable to third party effects of assignment of debt claims 5 IFRS 16 6 Insolvency law 6 Top banking cases from 2016 7 Contacts 9 RELATED LINKS Herbert Smith Freehills The definition of an "electronic signature", as set out in the Electronic Communications Act 2000 (ECA 2000) (as amended) is that: "an electronic signature is so much of anything in electronic form as is incorporated into or otherwise logically associated with any electronic communication or electronic data; and purports to be used by the individual creating it to sign". Electronic signatures can take a range of forms and include a person signing by: • typing their name into the document • using a stylus on a touchscreen device and • applying unique digital coding to a document as a form of identification (commonly known as a "digital signature"). What is an electronic signature? BANKING YEAR REVIEW 2016 HERBERTSMITHFREEHILLS 2 The Practice Note provides significant comfort to corporate parties wishing to use electronic signatures within their businesses and covers: • forms of electronic signature • the legislative framework of electronic signatures • using electronic signatures to execute English law documents • the evidential weight of electronic signatures • originals and counterparts • conflicts of law issues and • certain other considerations which should be considered in relation to electronic signatures, eg IT security and local registry requirements However, even with the Practice Note available, companies must still consider the legal risks and practical implications of using electronic signatures on a case-by-case basis. Furthermore, companies wishing to use electronic signatures should put in place clear internal policies to ensure that these risks are mitigated and addressed. Our briefing (here) provides a detailed overview of developments in this area, summarises the legal position of electronic signatures and identifies some of the benefits and risks associated with using electronic signatures. From a finance transactional perspective, some key considerations are set out below: • the practicalities of evidencing that a document was in fact signed (and witnessed, where relevant) correctly as a matter of English law, and the way in which a particular electronic signing platform accomplishes this, will need to be carefully considered in each case • it is unclear whether electronic signatures will be accepted if the parties seek to enforce or rely on an English law document outside England and the extent to which traditional comfort expected or required by overseas jurisdictions such as certified copies, notarisation or apostilling, will be possible where electronic signatures are used. Therefore where any litigation or other action in relation to such a document may take place, or be required, outside England (including other parts of the UK), parties should seek local legal advice • where a document is governed by a law other than English law (such documents being outside the scope of the Practice Note, including documents governed by laws of other parts of the UK), local law advice should be obtained • when dealing with an overseas company (however it is executing a document) it remains best practice to seek local law advice on formalities for execution and other related issues (eg capacity and authority) • documents which need to be registered at the Land Registry eg mortgages over land, must not be signed using electronic signatures since the Land Registry currently requires wet ink signatures on paper versions of documents submitted to it for registration. Introduction of various changes to the Companies Act 2006 by the Small Business, Enterprise and Employment Act 2015 (SBEE Act) The Register of People with Significant Control (PSC) As of 6 April 2016, UK incorporated companies and LLPs are required to keep a new statutory register providing details of people with significant control over them, and as of 30 June 2016, companies and LLPs are required to file this information at Companies House with their annual confirmation statement, creating a publicly accessible central registry of beneficial ownership information. In short, a person (X) will have "significant influence or control" over a company if one or more of the following conditions are met: (a) X holds, directly or indirectly, more than 25% of the shares or voting rights in the company BANKING YEAR REVIEW 2016 HERBERTSMITHFREEHILLS 3 (b) X holds the right, directly or indirectly, to appoint or remove a majority of the board of directors of the company (c) X has the right to exercise, or actually exercises, significant influence or control over the company or (d) X exercises or has the right to exercise significant influence or control over activities of a trust or firm which itself meets one or more of the conditions set out above. The principal concern in the context of secured lending transactions is that, in order to enforce these disclosure requirements, a company is entitled to serve various notices on shareholders it believes may be PSCs. The last resort is the issue of a "restrictions notice" to such a shareholder, the effects of which are that any transfer of that person's interest in the company is void, no rights are exercisable in relation to that person's interest and no shares can be issued in respect of that interest. There are some statutory protections for third parties: the issue of a restrictions notice is not mandatory, and in doing so the company must have regard to the effect of the notice on the rights of third parties. Also, anyone may apply to the court for a direction that certain acts will not constitute a breach of the restrictions arising from the restrictions notice. However, at this stage the timing and cost implications of such an application are not clear, so lenders may wish to seek to include contractual protections to deal with these risks (and the LMA has included some contractual comfort in its forms of facility agreement, including that group companies will comply with any such notice served on them). There is also a statutory protection for security holders, in that rights attaching to shares held by way of security will be treated as being held by the chargor in most lending transactions (unless voting rights have been transferred), and there is statutory guidance confirming that lenders would not, in the normal course of most typical lending transactions and subject to certain caveats, be considered to be PSCs. Members register may be kept at Companies House As of 30 June 2016, private companies may elect to maintain their members' register at Companies House. This could lead to a delay on enforcement of share security, since it adds a further step into the enforcement process, and again lenders may seek contractual protections to mitigate this risk. Brexit As you will be aware, the precise impact of Brexit on financing transactions remains unclear at this stage, pending further clarification of the likely arrangements following an exit from the EU. However, a brief summary of the principal issues is below. For more detail see the Brexit hub on our website here. This appears to remain one of the main concerns, in particular in relation to foreign exchange volatility where borrowers have non-sterling exposure. For example, financial covenants may be calculated partly based on a spot rate of exchange at a particular date and partly on an averaged rate over an accounting period. Where nonsterling debt obligations are hedged, counterparties may be required by their derivatives contracts to post further collateral, and if a position is closed out, there may be significant payment obligations if the contracts are out of the money. Market volatility Invoking a contractual material adverse change clause would, as ever, depend on the precise wording of the relevant clause. While the formulation of 'MAC' clauses is likely to be kept under review for the coming months for new financing arrangements, there is a high evidential burden required to prove that a material adverse change has been triggered. MAC clauses BANKING YEAR REVIEW 2016 HERBERTSMITHFREEHILLS 4 EU Bank Recovery and Resolution Directive 2014/59 (BRRD) – Article 55 – Contractual Recognition of Bail-in Requirement From 1 January 2016, Article 55 of the BRRD obliged EU Member States to make a change in national law which affects a wide range of contracts, including banking contracts. Article 55 is part of complex bank resolution legislation and is intended to give weight, outside the EU, to the powers of the EU resolution authorities to bail in, ie write down or convert into equity, liabilities of a failing in-scope entity to maintain it as a going concern. Broadly, Article 55 requires that if an EU regulated credit institution or investment firm enters into, or materially amends, any liability governed by the law of a jurisdiction outside the EU, it must, from 1 January 2016, obtain a contractually binding acknowledgement and agreement from the counterparty that the liability can be bailed in. Due to the wide range of liabilities to which the requirement applies, in-scope firms have found it very difficult to comply with Article 55 in some areas of business, ranging from trade finance documentation to membership of foreign clearing houses. Furthermore, despite the final draft of the European Banking Authority technical standards being adopted in March 2016, it is for national regulators to enforce and potentially provide flexibility in the application of the requirement. In the UK, some flexibility has been provided by amendments made to the PRA Rulebook on 1 August 2016 such that UK in-scope entities may request that the contractual recognition of bail-in requirement is dis-applied for "phase two" liabilities (ie, unsecured liabilities other than debt instruments) where including the bail-in clause is "impracticable". FCA-authorised firms may apply for a similar modification direction of the relevant FCA rule where compliance with the rule is impracticable. The FCA direction ends on 30 June 2017 (or earlier if the relevant rule is In the longer term, the impact on financing documentation governed by English law is likely to be relatively minor. While arbitration with a seat in London should not be affected by the exit from the EU, there is some focus on dispute resolution mechanisms, specifically on the question of enforcement of judgments, following an exit from the EU. In brief, it is likely that the UK would seek to reach an agreement with the EU on reciprocal jurisdiction and enforcement of judgments to replace the existing EU legislation on these matters and may join the Hague Convention on Choice of Court as an independent signatory which would protect the recognition of exclusive jurisdiction clauses and related judgments: the EU Member States are all parties to this Convention already. It is worth noting that in the absence of any specific agreement being reached, parties to transactions involving a submission to the English courts would be in the same position as they would be if they were party to New York law documents containing a submission to the New York courts. Contractual considerations In terms of the detail of financing agreements, any contractual reference to the EU as a geographical area would need to be considered, and may need to be amended to clarify the position following a UK exit from the EU. The wider effects of the UK potentially being a third country as far as the EU Bank Recovery and Resolution Directive is concerned should also be considered, primarily in the context of whether contractual bail-in language should be included in English law contracts to which an EU financial institution is a party. Documentary considerations The Financial Collateral Arrangements Regulations (which stem from the EU Financial Collateral Directive) are now fairly well entrenched in domestic law in the UK, and we expect that the UK would wish to retain a similar regime following an exit from the EU, given their importance in finance transactions generally. Financial collateral There may be a myriad of regulatory issues to consider since the regulatory position following a UK exit is still unclear. The principal issue will be in relation to potential loss of passporting for lending or the provision of other financial services in jurisdictions where licences to provide such services are required: financial counterparties will want to consider any illegality or other provision which may be triggered and may wish to amend the documentation to allow for affiliate entities which meet the relevant regulatory requirements to actually provide the service, or in the absence of any contractual ability to do so, may approach counterparties to seek transfers or novations. Regulatory issues BANKING YEAR REVIEW 2016 HERBERTSMITHFREEHILLS 5 revoked or amended before then). Notwithstanding these UK modifications, the requirement has continued to be problematic. More recently, on 23 November 2016, developments at the EU level indicate that change should be on the way with the release by the European Commission of a draft amending Directive of the European Parliament and Council and a Communication on "Call for evidence: EU regulatory framework for financial services". The call for evidence refers to the need to reduce unnecessary regulatory constraints on banks' ability to finance the wider economy and one of the examples given is to ensure that the contractual recognition of bail-in requirement can be applied pragmatically. It also acknowledges some of the difficulties which banks are facing when trying to comply and proposes a replacement Article 55. Although the current drafting of the proposed replacement does not appear to achieve the desired aim, it is to be hoped that Article 55 may become less problematic for in-scope entities during 2017. Ban on Big Four Auditor clauses June 2016 also saw a change in law which has resulted in any provisions in contracts between a company and a third party, such as a loan agreement, which restrict the company's choice of auditor to particular lists or categories, being void. Further, since there were no grandfathering provisions this applies to pre-existing contracts as well as new ones. Therefore, if amendments are being made to a contract entered into before June 2016, any such clause should be deleted, and new contracts being entered into should not contain such a clause. Financial Collateral The Court of Justice of the European Union has given its first ruling on the meaning of "possession" or "control" for the purposes of the Financial Collateral Directive (the FCD), following a referral from the Supreme Court of Latvia. The judgment does not materially depart from the existing English law position. The case covered several points of EU law: in its judgment the CJEU confirmed that the FCD regime can apply to monies deposited in a bank account. On the question of what constitutes "possession" or "control", the judgment states that a key part of the financial collateral regime is that the collateral taker is "in a position to dispose of the collateral when an enforcement event occurs". Therefore, where collateral is in the form of cash in an ordinary bank account, the collateral provider must be "prevented from disposing" of the monies in order for the collateral taker to be regarded as having "possession" or "control". More detail is provided by the opinion of Advocate General Szpunzar which was delivered on 21 July 2016 and which states that the key is that the collateral taker not only has practical control over the account but also has the right to prevent the collateral provider withdrawing the cash - that is a contractual clause giving the collateral taker the right to limit the use of the cash. However, there was no further guidance as to exactly what contractual controls would be required. This broadly reflects the current status of English law on the point, which emphasises that legal control over the collateral is required, and it does not fully settle the question of how to ensure that the collateral taker has "possession" or "control" of the collateral for the purposes of the FCD. WHAT'S COMING UP IN 2017 AND BEYOND? European Commission proposals for new rules to determine law applicable to third party effects of assignment of debt claims Following a report issued in September 2016, the European Commission is expected to launch a consultation in 2017 on its proposals for new EU rules to be put in place to determine the law which will govern the effectiveness of an assignment of a debt claim against third parties. Currently, the Rome I Regulation (EC No 593/2008) does not address which law governs the effectiveness of an assignment against third parties and national law differs. The Commission sees this, as well as questions of priority between competing third parties, as a crucial question to ensure legal certainty in cross-border business operations. The three possible approaches suggested are: • the law applicable to the assigned claim BANKING YEAR REVIEW 2016 HERBERTSMITHFREEHILLS 6 • the law of the contract between the assignor and the assignee or • the law of the assignor's habitual residence. IFRS 16 The new IFRS16: Leases was issued on 13 January 2016 and is due to be effective from 1 January 2019. It will require recognition of all identified leases on a lessee's balance sheet with only limited exceptions. (Currently, operating leases are not recognised on a lessee's statement of financial position; instead, operating lease commitments are disclosed in the notes.) The new IFRS16 may have an impact on, and could result in breach of, agreed financial covenants in loan agreements which are tested against the borrower's financial statements. However, any adverse effects may be mitigated or may even be prevented if a loan agreement contains "frozen GAAP" provisions (ie provisions which require the borrower either to ensure that all its financial covenants are calculated by reference to the same generally accepted accounting principles (GAAP) as those used when the loan agreement was entered into or to provide the lender with a comparison back to the original GAAP) or terms allowing renegotiation of covenants when accounting standards change. The LMA has amended its facility documentation to address the new requirements. However, lenders and borrowers still need to be aware of the changes and will need to address any issues which arise as a result, particularly in older documentation. Insolvency law Under the SBEE Act and related secondary legislation, further changes to insolvency law will come into force on 6 April 2017. These changes include the loosening of requirements to hold physical creditor meetings, the abolition of final creditor meetings and new procedures to enable creditors to opt out of receiving routine correspondence and office-holder reports (other than those relating to dividend payments). Small Business, Enterprise and Employment Act 2015 (SBEE Act) New Insolvency Rules 2016 will come into force on 6 April 2017 (IR 2016), replacing the Insolvency Rules 1986 (IR 1986). The IR 2016 are intended to simplify and modernise the IR 1986, principally by reducing certain procedural requirements and red tape. Insolvency Rules 2016 A recast version of EC Regulation 1346/2000 on insolvency proceedings, which seeks to harmonise the regulation and enforcement of insolvency proceedings among EU Member States by providing for the affairs of insolvent companies and individuals to be administered in the jurisdiction in which they have their centre of main interests, came into force on 26 June 2015. The Recast Insolvency Regulation will apply to relevant insolvency proceedings from 26 June 2017. Changes include: o a new three month "look-back" period which will be relevant when determining a debtor's centre of main interest and which aims to reduce abusive forum shopping o new procedural rules to improve co-ordination between insolvency practitioners in group insolvency situations and o the creation of a new Europe-wide insolvency register. Recast Insolvency Regulation ((EU) 2015/848) BANKING YEAR REVIEW 2016 HERBERTSMITHFREEHILLS 7 Top banking cases from 2016 Commitment letter was held to be legally binding In Novus Aviation v Alubaf Arab International Bank BSC(c)  EWHC 1575 (Comm) the Commercial Court found that a commitment letter which was stated to be "conditional upon satisfactory review and completion of documentation…" was legally binding. The Court also confirmed, obiter, that English law aims to uphold and give effect to the obligations of the parties to a document, not defeat them. The Court held that it was plain from the terms of the commitment letter that it was intended to create legally binding relations. It further held that any possible doubt about this conclusion was dispelled by the inclusion of a full governing law clause. It accepted that it is possible, in principle, for parties to create a document of which only part is intended to be legally binding. However, where that is intended, the Court indicated that it would expect to see the distinction between the two qualitatively different types of provision clearly signalled, which was not the case here. The Court further considered the inclusion of wording that the obligation was "conditional upon satisfactory review and completion of documentation… ". It found that there was no uncertainty in applying this test: whether the documentation was satisfactory to the bank was a question of fact. Further, the bank's ability to reject the documentation as unsatisfactory was not completely unqualified, but in the nature of a contractual discretion. In the absence of very clear language to the contrary, such discretion must be exercised in good faith for the purpose for which it was conferred, and must not be exercised arbitrarily or capriciously or unreasonably. If an express requirement for credit committee approval had been included as a condition precedent to lending, as would have been the case if the full LMA recommended form of mandate letter had been used, it is our view that this condition would not have been construed as a contractual discretion and therefore should have served as an effective reservation of the bank's right to decline the transaction on the basis that it was no longer in its commercial interests. A further complication was that the commitment letter had not been counter-signed by Novus. However, the Court confirmed that, in the absence of any stipulation that counter-signature was the only way in which Novus could signal its acceptance of the terms of the letter, its acceptance could be communicated by conduct. This case highlights that care must be taken when drafting commitment letters or comfort letters to ensure that it is very clear which provisions are intended to be legally binding and which are not. Any conditions to lending should be clearly set out. It also provides helpful clarification of the approach of the English courts to giving effect to agreements made between two commercial parties. For a longer form briefing, that was published at the time of the decision, please see here. Contractual interpretation of successive facility letters In Urban Ventures Limited v The Black Ant Company Limited (in Administration) and Ors  EWCA Civ 30, the Court of Appeal considered the question of whether further advances were made under consecutive facility letters issued to a company. The result of this would determine whether the first-ranking lender was entitled to tack such further advances on to its first legal charge, and so gain priority over Urban's second and third legal charges. In May 2016, the Insolvency Service published a consultation paper setting out a number of options designed to improve the existing corporate insolvency regime. The four main areas being considered are: • a new three month moratorium for distressed companies • a widening of the definition of essential supplies to allow distressed companies to maintain business-critical contracts • the introduction of a flexible restructuring plan that would bind both secured and unsecured creditors and introduce a "cram-down" mechanism and • amending the rules regarding priorities to allow rescue financing to be put in place. The responses to the proposals were not, in general, positive. The Government published a summary of the responses on 28 September 2016 and is understood to be continuing to review the proposals in light of the responses received. Further developments in 2017 are therefore awaited. Review of The Corporate Insolvency Framework BANKING YEAR REVIEW 2016 HERBERTSMITHFREEHILLS 8 In the circumstances the Court found that there was no new advance. It did not matter whether the subsequent facility letters took effect as a variation of the original facility letter or as a replacement for it: a new contract would not necessarily mean that there was a new advance since a new contract could relate to an existing advance. An advance is a payment of money on terms that it will be repaid. Since no funds moved in connection with the new facility letter, and there was no agreement between the parties that the existing loan should be treated as having been repaid and immediately re-lent, it was held that no new advance was made. Continuing or leaving outstanding an existing loan is not the making of a further advance. Therefore tacking did not arise. This was the case even though accrued but unpaid interest was rolled up and added to the principal amount outstanding under the new facility letter. However, the Court did note that if significant fees had been charged in connection with the renewal of the facility letters, it would have been necessary to consider the treatment of such new liabilities in more detail. Application of Unfair Contract Terms Act to a facility agreement In African Export-Import Bank and another v Shebah Exploration & Production Company and others  EWHC 311 (Comm) the Court considered, in an application for summary judgment, whether the Unfair Contract Terms Act 1977 (UCTA) applied to a facility agreement. The facility agreement was based on the LMA recommended form and was governed by English law. The facility agreement and guarantee contained standard provisions expressly excluding the exercise of any right of set-off by the obligors; the borrower made various counterclaims against the lenders which, it asserted, should be set off against the amounts which might otherwise be payable under the facility agreement. The borrower contended that it had an arguable case that the facility agreement constituted the lenders' written standard terms of business within the meaning of section 3 of UCTA and, accordingly, that the no set-off provisions could not be relied on unless they satisfied the requirement of reasonableness set out in section 11 of UCTA. The Court found on the facts that there was no basis for inferring that the lenders routinely put forward the LMA recommended form of agreement as a basis for their syndicated loan transactions or, indeed, that the lenders always refused to negotiate its terms. In any event, the Court considered that where commercial parties, represented by solicitors, have utilised a 'neutral' industry model form as the basis for a complex and detailed financial contract, executed after the usual process of negotiation, including revising a travelling draft, cogent evidence would be required to raise even an arguable case that the resulting contract was made on the written standard terms of one of those parties. Therefore the Court found no merit in the argument that the facility agreement was on the lenders' written standard terms of business. It followed that the no set-off provisions were not subject to the UCTA reasonableness test, but applied as per the terms of the agreement. Summary judgment was therefore granted to the lenders for the outstanding sums. Note, however, that an appeal hearing relating to this case is due to commence on 8 June 2017. BANKING YEAR REVIEW 2016 HERBERTSMITHFREEHILLS 9 Contacts Simon Chadney, Partner T +44 20 7466 2993 M +44 7717 760 048 firstname.lastname@example.org Will Nevin, Partner T +44 20 7466 2199 M +44 7810 378 622 email@example.com William Breeze, Partner T +44 20 7466 2263 M +44 7515 783 198 firstname.lastname@example.org Rachael MacKay, Professional Support Consultant T +44 20 7466 2836 M +44 7595 967 332 email@example.com Emily Barry, Professional Support Lawyer T +44 20 7466 2546 M +44 7912 394 311 firstname.lastname@example.org If you would like to receive more copies of this briefing, or would like to receive Herbert Smith Freehills briefings from other practice areas, or would like to be taken off the distribution lists for such briefings, please email email@example.com. © Herbert Smith Freehills LLP 2017 The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on the information provided herein. 10