Accountability - February 2014

12 February 2014

No more Mr Nice guy! Fail to adhere to court orders, rules and practice directions at your peril.

When the Civil Procedure Rules (CPR) were amended last year the revised overriding objective made it clear that the rules were in place to enable the court to deal with cases justly and at proportionate cost.

This objective was mirrored in the revised CPR 3.9 - the rule that governs the application a party may need to make if there has been a failure to comply with any rule, practice direction or court order. The revised CPR 3.9 requires the court to consider all of the circumstances of the case, including the need for "litigation to be conducted efficiently and at proportionate cost", however, it also makes it clear the rules are in place "to enforce compliance with rules practice directions and orders".

A number of recent court decisions have clearly shown that overturning a sanction imposed by the court will be far more difficult than it may have been pre-April 2013. The message is that failures to comply with court orders, rules or practice directions will be dealt with harshly, particularly where a sanction has been imposed.

As soon as the new rules went live there were suggestions that tough times may be ahead and that 'relief from sanction' may well be refused when it might have been granted under the old rules.

By August 2013 there seemed to be no doubt that the courts were taking a much tougher approach. In the case of Mitchell v News Group Newspapers Ltd, the High Court ordered that Mr Mitchell would be unable to recover the costs of his claim against NGN, as a result of a failure by his solicitors to file a cost budget (detailing the likely costs of his claim) as required by the CPR.

A cost budget is to be filed and exchanged by the date specified by the court, or if no date is specified at least seven days before the Case Management Conference (CMC), failing which the party in default will be treated as having filed a budget comprising only the applicable court fees. Mr Mitchell's budget was filed the day before the CMC and the court ordered that he was to be treated as having filed a budget limited to his court fees as a result. Mr Mitchell applied for relief from the sanction imposed and his application was refused.

Mr Mitchell appealed to the Court of Appeal, [2013] EWCA Civ 1537, and his appeal was dismissed at the end of November 2013. The judges recognised the decision was harsh on Mr Mitchell, however, it was required to ensure parties were clear in their understanding that failures to comply with procedural obligations will no longer be tolerated under the revised rules.

The judgment went on to say that "the court will usually grant relief if there has been no more than an insignificant failure to comply with an order: for example, where there has been a failure of form rather than substance; or where the party has narrowly missed the deadline imposed by the order, but has otherwise fully complied with its terms."

There has been a flurry of cases since Mitchell and there can be no doubt that the courts are taking a much harder line. In Durrant v Chief Constable of Avon & Somerset [2013] EWCA Civ 1624, the Court of Appeal overturned the decision of the trial judge to allow witness statements served late in a claim against the police. The defendants had served two statements a day late, but another four statements were served weeks out of time. All statements were served in breach of an unless order (requiring the statements to be served by a specified date or else they could not be relied on) and the defendants' application was not made promptly. As such, the right the defendants had to rely on witness evidence in support of their defence was lost.

The case of Long v Value Properties and another (13 January 2013 - unreported) also makes it clear that relief is unlikely to be granted even when there is an inadvertent error. In this case the claimant's action was funded by way of a pre-April 2013 Conditional Fee Agreement (CFA) and notice of the CFA had been given as required. The matter was settled and a detailed assessment was set to take place.

The claimant failed to serve the paying parties' solicitors with copies of the CFA and/or a statement setting out the details of the success fee. This was a breach of the old costs practice direction and as a consequence the claimant was not entitled to recover the uplift on the CFA. The claimant subsequently served the relevant documents and applied for relief from sanction.

Relying on Mitchell, the Master held that the non-compliance was not trivial (it was not simply a matter of form over substance). As the breach was not trivial, there had to be good reason to grant relief. Oversight, human error, or pressure of work was no longer a good reason for relief to be granted. Although the Master expressed qualms at the nature of the sanction imposed for the breach, unless the breach was trivial (it was not) or there was good reason for the breach (there was not) relief could not be granted. The success fee could not, therefore, be recovered from the paying parties.

The message coming from the courts is clear - make sure all rules, practice directions and orders are met. An application MUST be made to the court at an early stage if you think you may have a problem complying as required. The cases decided so far suggest that the courts will look more favourably on a party who applies to extend a deadline in advance than someone who applies after the date has passed.

Times have definitely changed; it seems that, even when a court has sympathy for a 'defaulter', if the breach cannot be regarded as trivial it is unlikely that relief will be granted. The default position in litigation going forwards must be to comply with all rules, practice directions and orders at the first time of asking.

The importance of setting out the scope of a retainer and an advisor's duty of care

The case of Richard Gabriel v Peter Little, High Tech Design & Build LTD, Whiteshore Associates LTD, BPE Solicitors, BPE Solicitors LLP ([2013] EWCA Civ 1513) has highlighted the importance of engagement letters in clarifying the scope of a professional retainer.

Mr Gabriel lent the sum of £200,000 to Whiteshore, secured on a property known as Building 428. The facility letter provided for repayment of the principal sum, together with an additional 'return' of £70,000, in March 2009. Mr Little owned a 50% share of Whiteshore and he was a director of the company. BPE acted for Mr Gabriel in relation to the loan transaction.

The facility letter which had been drawn up by BPE stated that the purpose of the loan was 'to assist with the costs of the development of the Property'. However, the money was actually used by Whiteshore to purchase the property from High Tech (Mr Little's principal company).

The loan was not repaid and Mr Gabriel exercised his rights under the charge to sell the property. The sale only realised £13,000, which did not meet Mr Gabriel's costs of the disposal. Whiteshore was contractually required to repay the loan, however, the company was insolvent and no longer existed as a legal entity. Mr Gabriel therefore claimed against Mr Little and High Tech for fraudulent misrepresentation, and against BPE for failure to exercise reasonable care and skill and for breach of trust by transferring the loan sum in question without informing Mr Gabriel as to its purpose.

At first instance Mr Gabriel's claims against Mr Little and High tech failed, and his claim against BPE for breach of trust. However, his claim against BPE for failing to exercise reasonable care and skill succeeded. The court found Mr Little and BPE had known the true purpose to which the money would be put, although BPE had failed to convey this to Mr Gabriel. Had he known this, Mr Gabriel was adamant that he would not have entered into the loan.

BPE was negligent in allowing Mr Gabriel to enter into the transaction without knowing its true nature. The court found that BPE should have explained that the funds would be 'applied substantially for Mr Little's benefit and in reality Mr Little was not putting anything at all into the project'; they were liable in damages to Mr Gabriel as a result.

BPE appealed and the Court of Appeal allowed the appeal. They did accept that BPE had a duty to provide Mr Gabriel with information for the purpose of enabling him to decide what commercial course of action he should take, but BPE had no duty to advise him on the course of action he should take or the commercial risks inherent in the loan.

Whatever Mr Gabriel may have thought as to the purpose of the loan there was no commercial agreement that Whiteshore would be obliged to spend the loan monies on development, or that BPE was instructed to make provision in the contract to that effect. Likewise Mr Gabriel accepted he had never approached BPE for commercial advice. BPE's duty was to inform not to explain - they did not have a duty to advise Mr Gabriel as to the course of action he should take or the commercial risks inherent in the loan.

The Court of Appeal went on to find that although BPE had failed to inform Mr Gabriel of the nature of the transaction, in breach of their duty of care, the losses suffered by Mr Gabriel fell outside the scope of their duty. The loss was not the foreseeable consequence of the lack of information, rather it was caused by several other 'risk factors' characteristic of a high-interest investment deal.

Despite the fact that BPE successfully defended the claim made against them in the end, the need for an appeal might have been avoided if BPE had properly set out the scope of their retainer and instructions at the start of the transaction. It was noted by the judge that BPE did not send Mr Gabriel a "client care" letter, or any other communication detailing their instructions.

This is a key issue. Institute of Chartered Accountants in England and Wales (ICAEW) recommends that an engagement letter is sent, to manage the risk of future disputes and to reduce the scope for misunderstandings. International Standards on Auditing (UK & Ireland) 210 also requires engagements to which those Standards apply to have terms of engagement that are recorded in writing. This case is an example of what can happen if such recommendations and requirements are not followed.

Applications for Pre-Action Disclosure - not such a high hurdle after all

The Court of Appeal has given clarification on the threshold that an applicant must meet in order to obtain pre-action disclosure.

Under rule 31.16 of the Civil Procedure Rules, the court may make an order for pre-action disclosure only where:

  1. the applicant and respondent are likely to be the parties to subsequent proceedings; and
  2. the documents sought by the applicant would be covered by standard disclosure in subsequent proceedings (together the 'jurisdictional threshold') and
  3. pre-action disclosure is desirable for fairness, to assist in avoiding proceedings, or to save costs ('discretionary test').

In the case of Smith v Secretary of State for Energy & Climate Control, [2013] EWCA Civ 1585, the applicant had worked for the National Coal Board for 30 years, spending many of those years in a noisy underground environment. He believed that he had suffered noise-induced hearing loss as a result.

He sought pre-action disclosure from the Secretary of State (the Coal Board's successor) of documents relating to noise tests carried out at the collieries where he worked, and of documents evidencing the Coal Board's consideration of the problems which could be caused by such noise. The District Judge granted an order for such disclosure. This was then overturned on appeal, the appeal judge in the County Court holding that the applicant needed to show "some kind of prima facie case which is more than a merely speculative punt", and that the applicant had therefore failed to meet the jurisdictional threshold for pre-action disclosure.

Delivering the leading judgment in the Court of Appeal, Lord Justice Underhill considered whether the jurisdictional test in the Civil Procedure Rules required the applicant to demonstrate a prima facie case. He found that it did not - jurisdiction was designed to be a low hurdle, in particular because pre-action disclosure is often necessary for a potential claimant to decide whether his case has merit and whether to bring proceedings. However, Underhill found that, in order to pass the jurisdictional test, the court need simply be satisfied that, if proceedings were brought, the applicant and respondent would be parties to those proceedings.

Underhill went on to say that, while the merits of the claim were not part of the jurisdictional threshold, the court would need to consider them as part of the exercise of its discretion. However, he held that the applicant need not prove that his case was arguable, or had good prospect of success - he merely needed to demonstrate some reason to believe that he had suffered a compensatable injury, which he was satisfied the applicant had done.

Lord Justice Longmore, agreeing with Underhill, added that applications for pre-action disclosure are not meant to be a mini-trial and that they should be disposed of swiftly and economically.

Contrast this decision with that in Assetco v Grant Thornton LLP. In this case an application for pre-action disclosure was refused. The court held the basis of the potential claim against Grant Thornton was not clear and the documents being sought would not have been covered by standard disclosure in the event of proceedings being issued.

It was also key that the type of claim would have required the Professional Negligence Pre-Action Protocol to be followed, in accordance with which an obligation to exchange information and documents pre-action would have arisen. The potential claimant was therefore premature in making its application.

It seems that a successful pre-action disclosure application requires the basis of the potential claim to be clear and for the documents requested to be ones which would ordinarily be disclosed during standard disclosure. It would appear, however, that the applicant will not need to prove that the claim is arguable on its merits.

There may be circumstances when disclosure of a party's insurance arrangements can be ordered by the court

In the case of XYZ v Various [2013] EWHC 3653 (QB) - part of the PIP Breast Implant litigation - a group of litigants was granted an order for disclosure of a defendant's insurance arrangements in respect of the defendant's potential liability in the litigation.

The claimants, a group of nearly a thousand women, seek damages from the companies operating various private hospitals which, they say, sold them defective breast implants manufactured by PIP. Certain defendants have already entered liquidation in the face of these claims.

Against that backdrop, the claimants applied for disclosure of the insurance cover held by the second defendant, Transform Medical Group Limited, against which 670 claims have been brought, with an average value of £13,000 each. They claimed that this information was necessary to understand whether Transform had sufficient insurance

  1. to fund participation in the litigation to the end of trial; and
  2. to meet any orders for damages and/or costs.

The court considered whether the claimants were entitled to such an order, pursuant either to Rule 18 of the Civil Procedure Rules ('Further Information') or to Rule 3 (the 'Court's Case Management Powers').

Part 18 permits the court to order a party to provide clarification or further information in relation to any matter which is in dispute in the proceedings. In this application, the court found that while the information sought (i.e. as to the defendant's insurance cover) might be of interest and relevance to the claimants in assessing whether the defendant would be able to meet any subsequent order for damages and/or costs, it did not pertain to a matter in dispute in the proceedings within the meaning of Part 18.

However, the court did consider that it was able to make an order for certain disclosure pursuant to its case management powers under CPR 3.1(2)(m). Mrs Justice Thirlwall held that, if Transform was not able to fund participation in the litigation to trial, that would have a bearing on the court's ability to manage cases in accordance with the overriding objective - i.e. justly and at proportionate cost, and consequently CPR 3 was engaged.

While the claimants were not entitled to disclosure of Transform's insurance cover for damages or costs, Transform was ordered to provide a witness statement setting out whether it had insurance adequate to fund the litigation to the conclusion of trial and any appeal, in order for the court to have adequate information on which to case manage the litigation.

Industry news

What's in a name? HMRC partnership tax changes

On 10 December 2013, HMRC published the 2014 Draft Finance Bill. Among the proposed changes is a proposal to address what the government views as disguised employment of individuals working as salaried partners in an LLP. The new rules will come into effect from 6 April 2014 (although anti-avoidance provisions came into force from 5 December 2013).

Disguised salary

Under the old rules, there was a presumption that a partner (or member) of an LLP was a self-employed individual. Such a status brought national insurance savings for firms. HMRC was concerned that some firms were labelling relatively junior employees as 'partners' in order to take advantage of these savings. Generally, HMRC is content to treat a partner as self-employed where they properly share in the decision making and the risks of the LLP as a whole.

The draft legislation sets out that HMRC will treat a salaried partner who is a member of the LLP as an employee of the LLP where:

  1. The individual performs services for the LLP and it is 'reasonable to expect' that the amounts he or she receives from the LLP are 'wholly' or 'substantially wholly' fixed and not, in reality, affected by the overall profits or losses of the LLP.
  2. The mutual rights and duties do not give the relevant individual significant influence over the affairs of the LLP.
  3. The individual's capital or similar contribution to the LLP is less than 25% of his or her disguised salary from the LLP in any tax year.

There has been some criticism of the above changes as previously the courts had looked at a range of factors when considering whether a member of the partnership was in fact a 'disguised employee'. The above criteria are an attempt to simplify the tests, though it remains unclear whether such a rigid criteria will be able to truly identify whether or not someone is a partner or an employee.

Mixed Member Partnerships

The government has sought to counter profit allocations that reduce or defer an individual's tax liability. The Finance Bill therefore introduces new rules for LLPs and partnerships with individual and company members (i.e. non-individual members) which, for tax purposes, will reallocate excess profits from a non-individual partner to individual partners where:

  1. The individual partner has the power to enjoy the non-individual's share (usually where the individual partner is a director or shareholder of the relevant corporate member) or there are deferred profit arrangements;
  2. The non-individual partner has a share of the firm's profit which is not an appropriate return for the services it has provided (or return on capital); and
  3. It is reasonable to suppose that the whole or part of the individual's share of the profits is as a result of the arrangement.

EU Audit Reform - all change

The topic of audit rotation and reform has been debated for the past decade and on 17 December 2013 the European Parliament voted to accept the European Commission's revised proposals for audit reform. This ended a long-standing impasse between the EU Council, EU Parliament and the Commission which had blocked reform since the original proposals had been made in 2010.

A final vote on the new proposals is to take place later this month (February 2014) after which the proposals will become law or a directive to all member states.

The proposals have been welcomed by the Financial Reporting Council (FRC) as opening the audit market to greater competition. They now follow the UK Competition Commission's introduction, in October 2013, of a requirement for companies to mandatory tender every 10 years (with those that tender less frequently required to set out clearly when an audit would be put out to tender).

While it remains unclear how the proposals will work in practice, some larger corporates have already announced tenders and in some cases changes to their long-standing auditors. Whether this is from shareholder or regulatory pressure remains unclear.

The proposals also throw light on the trend away from traditional audit work (as fee pressure has increased) and towards more lucrative consulting and advisory work. The International Accounting Bulletin (IAB) World Survey 2014, which was launched last month, showed a 9% drop in audit fee income (as a % of total fee income) in the Big Four between 2008-2013 and a rise of 10% over the same period in fee income from advisory work. This trend towards non-audit work seems likely to continue as the new reforms take hold.

The key aspects of the current proposals are:

  • Mandatory audit firm rotation every 10 years (extendable by 10 years on tender or 14 years where there is a joint audit);
  • Big Four only clauses to be prohibited;
  • Prohibitions on the provision of non-audit services to audit clients (including tax advice and services linked to the financial and investment strategy of the audit client);
  • Non-audit fees where services are provided to audit clients capped at 70% of the audit fee;
  • A Single Market for statutory audit: The new rules to provide a level playing field for auditors at EU level through enhanced cross-border mobility and the harmonisation of International Standards on Auditing (ISAs);
  • Incentives for joint audit and tendering and a proportionate application of the rules will be applied to avoid extra burden for small and mid-tier audit firms.
  • Cooperation between national supervisors enhanced at EU level, with a specific role devoted to the European Markets and Securities Authority (ESMA) with regard to international cooperation on audit oversight.

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