We look at the legal and industry news affecting accountants and other financial professionals on a range of liability risk management issues
The duty to mitigate - a game of two halves
The Commercial Court decision in Symrise AG v Baker & McKenzie in March neatly illustrates the importance of taking reasonable steps to mitigate any tax liability and not assuming that recovery can be made against tax advisers.
The claim arose out of inter-company debt restructuring following an acquisition which was designed to achieve maximum tax efficiency. The intention was to 'push down' borrowing to subsidiaries in certain jurisdictions, including Mexico, in order to obtain tax relief on interest payments.
Debt was pushed down to the Mexican subsidiary pursuant to an Inter-Company Loan Agreement (ICLA), clause 3 of which could be interpreted as providing for payment of the loan on demand. The amount of interest on the loan more than eliminated any profit and, therefore, any tax. Perhaps unsurprisingly, the Mexican Tax Authority (the MTA) investigated.
The MTA argued that the interest payments were in reality dividends, so the Mexican subsidiary was not entitled to any tax relief. They relied on three different grounds, one of which was that the drafting of clause 3 of the ICLA (specifically the reference to payment on demand) engaged Article 92(1) of Mexican Income Tax Law so as to prevent the interest payments being deductible in line with the push down strategy. The other two grounds did not give rise to any claim against the defendant.
The claimant paid some of the MTA demands but then issued nullity proceedings to challenge the MTA determination and recover the tax paid. However, nine months later they abandoned those proceedings and settled in full with the MTA. They then sued the defendant.
The defendant admitted in evidence that one interpretation of clause 3 in the ICLA had been payment on demand and that this could have led to challenge by the MTA. They also admitted that the terms of the ICLA could easily have been amended to remove the "on demand" wording. Accordingly, liability was clear cut and the defendant was found to have been negligent and in breach of their retainer. That breach was accepted by the court to have been a concurrent and effective cause of the MTA's investigation which led to the settlement with the MTA.
Any celebration by the claimant was to be short-lived however as the court went on to consider whether the steps taken by the claimant to abandon the nullity proceedings and do a deal with the MTA had been within the reasonable range of responses. It concluded that they had not.
The claimant settled with the MTA without obtaining any independent advice on the merits of the nullity, despite having had firmly optimistic advice from the defendant at an earlier stage that they were likely to be successful. In his view, there was no good reason for them to have abandoned proceedings when they had a very good chance of winning.
This is a reminder to all claimants that they must act reasonably to mitigate their loss and, in particular, consider the merits of any tax challenge before deciding to abandon it and sue their advisers.
The question of whether or not a claimant has acted within a reasonable range of responses is a question of fact in each case. There could be commercial reasons for a settlement but these may not be enough to establish mitigation where there are otherwise reasonable prospects of success and no other external factors, such as impecuniosity.
General points rejected by Mr Justice Burton included arguments that the claimant wanted to avoid protracted litigation; and to present a good "face" to the MTA. He also expressly warned claimants against believing it reasonable to accept a tax liability if they only do so because they can make recovery against a negligent adviser.
It is also worth remembering that if the claimant had pursued the nullity proceedings and lost, they would have made a recovery from their advisers, including any mitigation costs. In hindsight, perhaps this was a risk worth taking.
Getting the name right - a simple mistake can mean the end of a claim
The importance of ensuring a defendant is correctly named in proceedings issued against it was highlighted again in the recent decision in American Leisure Group v Olswang LLP.
The matter involved a claim by American Leisure Group (ALG) against Olswang LLP (OLLP) for negligent legal advice given six years previously. After proceedings had been issued it became apparent that the legal advice in question had been given by the LLP's predecessor, the partnership firm of solicitors (Olswang).
ALG accepted that they had no claim against the LLP and, as the limitation period for a new claim had now expired, they made an application under Civil Procedure Rule (CPR) 19.5 to substitute the name of the defendant from OLLP to Olswang.
At first instance the Master held that while he did have jurisdiction to allow substitution of the defendant under CPR 19.5, he would exercise his discretion not to do so. The existing claim against OLLP was therefore struck out.
ALG appealed the Master's decision not to allow the substitution, and OLLP cross-appealed against the Master's decision that he had jurisdiction, contending that the mistake made by ALG was not a mistake that permitted substitution under CPR 19.5.
Questions for Appeal
The High Court had three issues to consider on appeal:
- Whether the Master had jurisdiction to substitute the defendant under CPR 19.5;
- If yes to point 1, whether the court could interfere with the exercising of the Master's discretion; and
- If yes to point 2, whether the Master had erred in his use of his discretion.
- The Master did have jurisdiction to substitute the defendant under CPR 19.5. In coming to his decision the Master had considered the particulars of claim and was satisfied that the mistake was one of name rather than the identity or description of the party. ALG did not mistakenly believe OLLP was liable for the advice given by Olswang, rather there was a failure correctly to name the party who provided the legal services. The High Court agreed with the Master's approach and OLLP's cross-appeal was dismissed.
- The High Court did have limited jurisdiction to interfere in case management decisions (and the decision whether or not to allow substitution was a case management decision) and it could consider whether the Master had properly exercised his discretion not to allow the substitution. However the High Court confirmed that it could only intervene if the Master had made an error of principle or reached a decision which had been made outside the Master's own ambit of discretion.
- The Master had not erred in the use of his discretion not to allow the substitution. The Master was correct to consider the long delays of AGL throughout the proceedings, including the delays in issuing the claim form and serving particulars of claim, the delay in responding to the strike out application made by OLLP and the delay in bringing the application to substitute OIswang for OLLP.
The Master was also correct to consider the fact that the pre-action protocol for professional negligence claims had not been followed and the fact that ALG had failed to enter into any correspondence with OLLP or Olswang before proceedings were issued - neither OLLP or Olswang had any idea of the potential claim until months after the limitation period had expired. The Master could not therefore be criticised for taking into account the fact that Olswang would have been deprived of a limitation defence if he had exercised his discretion in favour of ALG. The appeal was therefore dismissed.
This case is a clear reminder of the need to ensure a claimant has correctly named the defendant in the proceedings before the claim is issued. While it might be possible to substitute a defendant under the CPR if a mistake is made the reality might be very different.
If a mistake is made a claimant needs to ensure steps are taken to rectify the mistake as soon as possible, as any delay may well be prejudicial to the application - particularly if the limitation period for bringing the claim has expired.
Furthermore, any potential claimant should ensure that any relevant pre-action protocol - or the Practice Direction on pre-action conduct - is followed before steps are taken to issue proceedings. If the protocol / practice direction is followed, any issue with a defendant's name is likely to be highlighted before proceedings are issued and the ability to rectify a mistake becomes more difficult.
Steps to be taken before a professional negligence claim can be issued
The Pre-Action Protocol for Professional Negligence claims (the Protocol) should be followed before any claim for professional negligence is issued. Its importance should not be underestimated, as is highlighted in the American Leisure Group v Olswang LLP case we have reported on above.
If a claim for professional negligence is issued without the Protocol being followed, the professional should immediately inform the claimant that there is an obligation on them to complete the Protocol steps - and a stay (a temporary pause in the proceedings) should be sought to allow the Protocol to be followed.
The Protocol itself has recently been amended. It is now described as 'a code of good practice' that 'contains the steps which parties should generally follow before commencing court proceedings in respect of a professional negligence claim'.
In general the revisions make it clearer that the aim of the Protocol is to assist parties in settling their disputes without the need for proceedings to be commenced.
The revisions include providing that if a claimant is unrepresented a copy of the Protocol must now be included with the professional's acknowledgement of the claim that has been made against it in the letter notifying the professional of the claim (the Preliminary Notice).
If, after sending the Preliminary Notice to the professional, the claimant does nothing further for a period of six months, the claimant is now required to notify the professional in writing as to its intentions with regard to the claim. This should assist the professional to understand what is happening rather than continually waiting to see if a claim will be pursued.
There are also new provisions that encourage the 'early exchange of relevant information and documents', although they also make it clear that the Protocol should not be used to justify a 'fishing expedition' by either party and that there is no obligation to disclose any document a court would not order to be disclosed pre-action.
On alternative dispute resolution (ADR), the Protocol now makes it clear that, in the event proceedings are issued, a party's refusal to engage or silence in response to an invitation to participate in ADR might be considered unreasonable by the court and could lead to the court ordering that party to pay additional costs. This reflects recent decisions which show the court's view that ADR cannot be ignored.
There is a new provision called 'Stocktake' which requires the parties to undertake a further review of their respective positions if, having followed the Protocol, the dispute has not been resolved. The parties are now encouraged to 'consider the state of the papers and evidence in order to see if proceedings can be avoided and, at the least, narrow the issues between them'.
Finally, there is now a specific provision encouraging the parties to apply for a stay of proceedings - if proceedings are commenced before the Protocol has been followed. As confirmed above, a stay should be agreed or ordered - allowing the proceedings to be temporarily halted while the Protocol steps are concluded - in the hope that the claim can be settled.
- The FRC substantially reduces the fine imposed on Deloitte in the MG Rover case
- The Companies, Partnerships and Groups (Accounts and Reports) Regulations 2015 came into force on 6 April 2015
- The Small Business Enterprise and Employment Act 2015 receives Royal Assent
FRC substantially reduces the fine imposed on Deloitte in the MG Rover case
We reported in our February edition of Accountability that a Financial Reporting Council (FRC) appeal tribunal (the Appeal Tribunal) had overturned eight out of the 13 findings of misconduct made against Deloitte by the disciplinary tribunal (the Disciplinary Tribunal) in September 2013, including the core findings of deliberate misconduct and failure to act in the public interest.
That decision has now resulted in the record £14 million fine imposed on Deloitte in 2013 being reduced to £3 million, and the fine against Magsoud Einollahi (the former Deloitte partner) being reduced from £250,000 to £175,000.
In considering the level of the fine that should be imposed on Deloitte and Mr Einollahi as a result of the decision of the Appeal Tribunal in February, the tribunal considered that the following factors were relevant:
- the previous record of Mr Einollahi, Deloitte's reputation and the fact it had no previous significant findings of misconduct;
- Mr Einollahi's work in trying to seek the survival of MG Rover - most of which was not subject to criticism;
- the considerable time the matter has been pending and the associated stress and concern of those involved; and
- the effect of the unwarranted finding of deliberate misconduct and of the findings of misconduct that were set aside.
The Tribunal noted that the reduced fine nonetheless reflected:
- the failure by Deloitte and Mr Einollahi to consider conflicts and the interests of MG Rover and their consideration of the interests if the Phoenix Four and the Phoenix Partnership;
- the sums of money involved and potentially involved and the importance of MG Rover and its business to a large number of people - and therefore the impact or potential impact of the misconduct;
- Mr Einollahi's experience, seniority, leadership and responsibility and the time during which the misconduct continued;
- the need to mark disapproval of the misconduct, to emphasise publicly that it was unacceptable and to promote public confidence in the regulation of the profession;
- the need to make it clear to the profession that such conduct will meet a substantial sanction.
The Companies, Partnerships and Groups (Accounts and Reports) Regulations 2015 are now in force
On 30 March 2015, The Companies and Groups (Accounts and Reports) Regulations 2015 (the Regulations) were published. The Regulations implement Chapters 1-9 of the EU Accounting Directive into UK Law. The Directive looks to simplify accounting requirements for small companies and also provides more clarity and comparability of financial statements for those companies within the EU.
The Regulations came into force from 6 April 2015 and amend the law relating to the preparation of annual accounts of companies and related matters such as the filing of accounts.
The Regulations are applicable for financial years commencing after 1 January 2016, although early adoption is allowed for financial years commencing on or after 1 January 2015. The only exception to this early adoption is that the increased size limits cannot be adopted so that a company is exempt from audit until 2016.
The Regulations also include a requirement for companies to include full details of subsidiaries in the consolidated financial statements. This comes into force earlier and is applicable for annual accounts approved on or after 1 July 2015.
It should be noted that the changes in the Directive only apply to companies and 'qualifying partnerships' who are preparing accounts under the Partnerships (Accounts) Regulations 2008. They do not currently apply to Limited Liability Partnerships.
The Regulations also amend the Companies Act 2006 to increase the size criteria which determine whether or not a company qualifies as small or medium.
- For a company to qualify as small the criteria for turnover increases from "not more than £6.5 million net" to "not more than £10.2 million net", and for balance sheet total the criteria increases from "not more than £3.26 million net" to "not more than £5.1 million net".
- For a medium sized company the criteria for turnover and balance sheet increases from "not more than £25.9 million net" to "not more than £36 million net", and from "not more than £12.9 million net" to "not more than £18 million net" respectively.
The Small Business Enterprise and Employment Act 2015 receives Royal Assent
The Small Business Enterprise and Employment Act 2015 (the Act) received Royal Assent on 26 March 2015. The Act includes a number of provisions which are intended to reduce red tape around company filing requirements while increasing the quality of information on the public register. It also seeks to enhance transparency in corporate ownership.
The key changes, as they are expected to come into effect, are:
26 May 2015
- Bearer shares are abolished and any existing share warrants must be surrendered in exchange for registered shares.
- It will no longer be possible to appoint corporate directors and companies must give notice that corporate directors have ceased to be a director. We await further guidance as to whether there will be a principles-based exception to this prohibition and what form that will take following a consultation by BIS earlier this year.
- UK companies will be required to keep a Person with Significant Control (PSC) register. A PSC is someone who owns or controls more than 25% of a company's shares or voting rights or who otherwise exercises "significant influence or control" over a company or its management. The register must include details of every PSC's name, date of birth, nationality, address and details of their interest. This information must be filed at Companies House from April 2016. Further guidance is expected in October 2015 as to what is meant by "significant influence or control".
- The obligation to file an annual return is replaced with a requirement to check and confirm company information at least every 12 months on a date of the company's choosing.
- Private companies will be able to opt to keep certain information on the public register rather than maintaining statutory registers. This will apply to registers of members, directors, secretaries, and directors' residential addresses; as well as the PSC register. Companies can also volunteer to make additional information available on the public register.
- The information contained in the statement of capital is simplified.
- The date of birth of any director or PSC on the public register will be partially supressed by removal of the day to prevent identity fraud.
- A faster strike off regime will be introduced to remove defunct companies from the register and ensure it is accurate and up to date. In a similar vein, it will be simpler to remove inaccurate registered addresses.