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This article was first published by Solicitors Journal on 17 April 2012, and is reproduced by kind permission

The cases of Key2Law (Surrey) LLP – v – De’Antiquis and Spaceright Europe Limited – v – Baillavoine have provided further clarification as to the protection afforded to employees under TUPE in the case of a transfer of an employer’s business and assets in an Administration.  The position had been unclear following the decision of the Employment Appeal Tribunal in Oakland –v- Wellswood (Yorkshore) Limited in 2009.

The Transfer of Undertakings (Protection of Employment) Regulations 1981 and 2006  (TUPE) confers on employees certain rights in the event of a transfer of an employer’s business.  TUPE provides that employees will automatically transfer to the transferee on their existing terms of employment and the transferee will then inherit employment liabilities and obligations in relation to them.   Further, a dismissal which was connected to the transfer will be automatically unfair, unless the reason is economic, technical or organisational (referred to as an “ETO” reason), entailing changes in the workforce.

Clearly, the potential adoption of liability under employment contracts would discourage purchasers of insolvent businesses and so the government introduced provisions in order to assist by adding some flexibility.

TUPE provides that, where the employer is subject to “bankruptcy proceedings or any analogous insolvency proceedings which were instituted with a view to the liquidation of the assets of the transferor”, employees would not automatically transfer to the transferee and a dismissal for reasons connected with the transfer would not be automatically unfair.

TUPE also provides that, where there are “relevant insolvency proceedings” (being “insolvency proceedings which have been opened in relation to the transferor not with a view to the liquidation of the assets of the transferor and which are under the supervision of an insolvency practitioner”) there would be greater scope to vary the terms of employment, where the variation is designed to safeguard employment by ensuring the survival of the business or part of it.

There have been a number of decisions in the Employment Tribunal and above that have demonstrated the shortcomings in TUPE, and more particularly the definitions of “relevant insolvency proceedings” and “bankruptcy proceedings or any analogous insolvency proceedings”  when it comes to be applied to an administration.

It is important to understand the difference between an administration and a liquidation.

The statutory purpose of an administration is to achieve one of the following objectives:

• The rescue of the company as a going concern; and only if that cannot be achieved
• The achievement of a better result for the company’s creditors as a whole than would be likely if the company were wound up; and if that cannot be achieved
• The realisation of some or all of the company’s property to make a distribution to one or more secured or preferential creditor.

Often, the administrator, once appointed, will trade the company either with a view to rescuing it and returning it to its directors (albeit this is rare) or in order to preserve goodwill and avoid termination or breach of contracts whilst the business is marketed for sale.

Conversely, the purpose of a liquidation is to sell assets and distribute them to creditors.  A company can only trade in liquidation in so far as it is necessary for the beneficial winding up of the company and even then the permission of the Court may be required.  A liquidation procedure therefore fits squarely into the definition of a process “with a view to the liquidation of the assets” whereas an administration process does not.

Administrator objectives

It is not always clear, at the outset of an administration, what the objective of the administrator may be and it may change as the possibility of achieving the primary and/or secondary objective disappears.  There is no obligation upon the administrator to state his objectives until he makes his proposal to the company’s creditor’s which may be up to 8 weeks after the administration.  His only obligation is to consider each of the objectives and either perform the administration so as to achieve the primary objective or dismiss it and move onto the secondary and possibly the tertiary objective. To that extent an administration should always be commenced with a view to rescuing the company as a going concern.  Does that mean that an administration can never be considered to have been carried out with a view to liquidation of assets, regardless of the actual outcome, such that it would never be possible to avoid the consequences of TUPE and that a dismissal connected to a transfer of the business would be automatically unfair?

In practice, very often the second or third objective is achieved by selling the assets of the business in one go so that the business is sold as a going concern.  Effectively the insolvent company’s assets will have been liquidated albeit the business will have been preserved through the sale.   Sometimes this will happen after a period of trading whilst in administration. Sometimes the buyer is found before the company goes into administration and the sale effected upon administration in order to preserve the goodwill and trade of the business (a “pre-pack” sale).  Often, once the business has been sold the company quickly moves into a liquidation.  Does that mean that such administrations were commenced with a view to liquidation of assets or does it depend upon whether there was a post-administration period of trading?

In Oakland the insolvent company had been sold back to its director and shareholder on the day that it went into administration. The Employment Appeal Tribunal decided that, in circumstances where the company would not trade in administration and would shortly enter into liquidation, this was “bankruptcy proceedings or any analogous insolvency proceedings… instituted with a view to the liquidation of the assets of the transferor” such that the employees did not automatically transfer to the transferee.  The Employment Appeal Tribunal did not say that this would always be the case but considered that it would be a question of fact to be determined by the Court.  This would mean that a Court would have to reconstitute the circumstances existing at the time of the commencement of the process and the objective of the administration in the mind of the administrators at that time.

Not only would this decision mean a great degree of uncertainty as to the rights of employees against transferees and the risk of a transferee adopting employee liabilities but the decision would encourage the use of  pre-pack administration where the purchaser would, on this view, be able to take the business free of employee liabilities.

Seeing clearly

A contrary view was adopted by the Employment Appeal Tribunal in OTG – v – Barke.  However, the Court of Appeal has recently considered the issue in two cases which now provide much needed guidance on the position.

In 2011, in Key2Law, the Court of Appeal considered the effect of an administration on employees.  In this case a company went into administration in the hope that a buyer could be found but it wasn’t. Instead firms of solicitors were engaged by the administrators to carry out the work of the company as its agent.

The Employment Appeal Tribunal had considered that the aim of an administration was not a question of fact but was absolute, depending upon the procedure adopted and that, since the primary aim of an administration is to rescue a company as a going concern, it would not be a process analogous to bankruptcy.  The Court of Appeal agreed, accordingly employees of companies in administration would automatically transfer to a transferee and be protected from dismissals by reason of the transfer of the business.

In Spaceright, the business and assets of the company were sold one month after the company went into administration.  At the time of the administration a buyer of the business had not been identified.  The Court of Appeal had to decide whether the dismissal of the managing director of the company was connected with the transfer of the business.  It decided that it was, notwithstanding that the actual buyer was not in contemplation at the time of the dismissal.  This is an important clarification.  Further, the Court considered that the dismissal did not relate to the ongoing business, for example, a general reduction in the number of employees to assist trading as a going concern, accordingly the dismissal was not for an ETO reason and was unfair.

Purchasers of the business of companies in administration, and other transferees, need to be aware that they are likely to adopt liabilities in relation to employees.  Purchasers should be advised that employment liabilities cannot be avoided by reaching an agreement with the administrators of the seller that they will procure the dismissal of employees before the sale of a business and assets. This is an important consideration for purchasers in any purchase but where there is a sale by an administrator, a purchaser cannot expect an indemnity from the seller or the administrator in relation to any liabilities that the purchaser may find that they have adopted.  Indeed, administrators will often insist on the purchaser providing an indemnity in favour of the seller and invariably in respect of himself, in respect of any claims subsequently made by employees against them.

All too often purchasers are unaware of this risk and the question of employment liabilities becomes a “deal breaker”.  Either the sale will fall away, potentially damaging the value of the business, or the purchaser will negotiate a reduction in the purchase price, reducing the return to creditors, or the purchaser will have to take the risk that it may have to take on employees that it does not need and/or risk employment claims from employees that are or have been involved in the business.  The claims that may be made against a purchaser may be substantial, including claims for failure to consult employees in relation to a transfer.  Liability for such failure may amount to up to 13 weeks pay per employee.

Policy decisions

Pre-pack sales of businesses out of an administration have received a great deal of bad publicity in the press fuelled by unpaid creditors left high and dry.  However, it is well established that the advantage of a “pre-pack” sale in an administration is that jobs are usually saved.  The government has considered whether pre-pack sales should be outlawed or further regulated.  Whilst more stringent reporting requirements and duties have been imposed upon administrators, in an attempt to avoid sales back to directors of an insolvent business, for the purpose of avoiding having to pay creditors, proposals that creditors should receive notice of an intended sale have been dropped.

Ultimately the government has a policy decision to make as to whether legislation protects creditors or employees.  Particularly in the current economic environment, the interests of employees must be considered to be paramount. That said, in general a sale of a business as a going concern is likely to result in a higher return to creditors (albeit it is usually secured creditors that benefit) than a break-up sale of assets, in a liquidation, would achieve.  Further, where employee liabilities transfer to a buyer of the business, the level of liabilities in the insolvent company is reduced thereby potentially increasing the level of any distribution of funds in the administration to unsecured creditors.

At its best, Oakland created a period of uncertainty when many purchasers may have been comforted by the decision and held the view that employment liabilities for dismissed employees would rest with the insolvent company.

At its worst, the decision potentially meant that the transfer of employment rights could be avoided when a business was sold out of an administration process.  This is entirely contrary to the understanding of insolvency professionals and the basis upon which policy upon administrations has been formed.  The decisions in Key2Law and Spaceright must therefore be welcomed.

Denise Fawcett
Partner
T: 0207 634 0642
E: dfawcett@pitmans.com

A review commissioned by the Government has decided that employers who prioritise job applicants with top degrees from top universities are potentially discriminating against those with degrees from other universities. It has been suggested that three quarters of employers require good grades as a minimum but that this requirement goes against an employer’s duty to hire a diverse workforce.

This is all very well but given competition for jobs is at an all time high one has to ask whether it is unreasonable for employers to want to recruit the best person for the role available. It seems logical that the best person should be recruited for a role. However it is not always the case that the best person is necessarily the one with the best grades. It has long been standard practice to require a certain level of grades to apply for certain jobs but due to the current economic condition such a level has had to be raised to try and help limit the number of applications.

Of course a person may excel academically but have no social skills and so not be able to work well in the workplace. Thus going against the idea that those with the best grades are the ones best for the job Employers would do well to recognise this and look beyond academic grades.

It must also not be overlooked that there are able candidates from universities which are not able to compete with the elite. They may have achieved a top mark from a lower tier university but the stigma employers attach to their university goes against them. It is perhaps this which employers should be warned against – do not make assumptions based on someone’s university as you may miss out on the person best for the job. Not only this but it leaves employers open to a real risk of discrimination.

A person could bring a claim of indirect race discrimination if employers are only recruiting those from elite universities. If an employer has a policy not to interview applicants from certain universities then they may be indirectly discriminating on the basis of their race. Those who do not have the opportunity to attend elitist universities because of their race are clearly disadvantaged by a policy only to consider applicants from such universities. However, it would be open to the employer to seek to objectively justify such a policy. The decision on whether to employ someone should not be influenced by irrelevant factors.

An individual may have a good reason for not attending a top university or given the amount now being charged to attend university, the cost each university charges may have made the decision for them. The elite universities will be charging the maximum amount possible and so it is quite possible the normal Joe Blogs will not be able to afford this or wish to incur the debt. Likewise there will be individuals who failed to achieve top grades for various reasons but are still just as able to do the job very well. Employers should recognise this and be willing to make concessions and take this into consideration.

For further information please contact Pitmans’ Employment Team.

Mark Symons
Partner, Head of Employment
T: 0118 957 0340
E: msymons@pitmans.com

Richard Devall
Partner
T: 0118 957 0602
E: rdevall@pitmans.com

This article first appeared in Solicitors Journal www.solicitorsjournal.com

Nortel and Lehman decision is upheld

The Court of Appeal has upheld the decision of the High Court in the matters of Nortel GMBH and Lehman Brothers International (Europe) (both in administration).  The High Court had decided that liability under a Contribution Notice issued by the Pensions Regulator against a company in administration or liquidation, in relation to liabilities of a defined benefit pension scheme, is an expense of that insolvency process.  Accordingly, this further extension of the types of expenses that have super-priority an insolvency process is confirmed. 

This decision will be of enormous concern to office holders who may find themselves with insufficient funds available, after payment of Contribution Notice liabilities, to fund their own remuneration and to floating charge holders and unsecured creditors who will find the funds available to them to satisfy their claims depleted.

Financiers will need to factor into lending decisions the possibility of substantial liabilities, not shown on a company’s balance sheet that would, if they arose, have priority over much of the secured and all unsecured lending.

Industry groups will continue to lobby the government for a change in legislation.  The government will have to balance protecting pension schemes, and therefore the Pension Protection Fund, at the cost of trade creditors and even HMRC and stifling investment and lending into groups with a final salary pension scheme.

Paymex Repayments Guidance

R3, the Debt Resolution Forum and other recognised professional bodies have issued a guide to the practical implications of the decision in Paymex Limited –v- The Commissioners for Her Majesty’s Revenue and Customs.

In this case, the First Tier Tax Tribunal held that the services of a company that arranged and implemented individual voluntary arrangements (“IVA”) were exempt from VAT since these services constituted negotiation in relation to debts and handling of payments, which attract the exemption under Article 135(1)(d) of Council Directive (EC) 2006/112/EC.  The Tribunal held that the question of whether a supply is exempt depends upon an objective economic assessment of the nature of the supply being made and not the nature of the taxable person making the supply. 

HMRC has confirmed that it will not be appealing the decision and will pay claims for overpaid tax falling within the findings of the Tribunal decision in this case.  Refunds must be treated as third party funds and paid into the relevant estate accounts or, where a case is closed, into client account, to be distributed without delay.

As it is the nature of the supply that needs to be considered in order to determine whether the supply is exempt from VAT, it appears that services relating to Company Voluntary Arrangements and Partnership Voluntary Arrangements could also be exempt.  However, HMRC has said that it will only consider refunds within the scope of the Paymex decision and, therefore, this will only apply to IVA’s.

Duty of Good Faith in IVA’s

In Kapoor –v- National Westminster Bank plc the debtor proposed an Individual Voluntary Arrangement.  He procured that one of his friends, an unconnected person, would pay a sum to a connected creditor, being more than the return in the Individual Voluntary Arrangement, in return for an assignment of part of the debt (thereby constituting an equitable assignment).  The friend then voted in favour of the IVA and outweighed the votes of other creditors opposed to the proposal. 

The Court of Appeal held that an equitable assignee of a debt could vote upon an IVA proposal.  However, it held that the debtor had a duty to be open and transparent in return for avoiding the investigations that would be likely in the event of a bankruptcy.  The assignment was on terms that were not commercial and was effected for the sole purpose of securing the approval of the IVA against the wishes of the general body of creditors.  On those grounds the IVA approval was revoked.

No Extension of Invalid Administration Appointments

There have been a number of cases recently looking at whether procedural irregularities may render an administration appointment invalid.

The case of Re Frontsouth (Witham) Limited is another in this line of cases.

An extension of the period of the administration had been obtained, purportedly, with the consent of the charge holders.  However, one charge holder had acknowledged the request for consent but had not given a full response.  

On the second application to the Court to extend the administration, the absence of the charge holder’s consent came to the court’s attention.

Paragraph 77(1)(b) of Schedule B1of the Insolvency Act 1986 provides that the administrators’ term of office may not be extended after the expiry of that term. If the first extension was invalid then the term of the administration would have expired and the Court would lack the jurisdiction to extend the term of office unless the defect could be remedied. 

This was particularly problematic since, during the extended periods of the administration, properties had been sold. 

The administrators asked the Court to use Rule 7.55 of the Insolvency Rules 1986 to find that the appointment was valid notwithstanding the procedural error.  Rule 7.55 provides that no insolvency proceedings shall be invalidated by any formal defect or irregularity unless the Court considers that substantial injustice has been cause by the defect or irregularity which cannot be remedied by Court order.

The Court refused to make an order extending the administration.

During the course of giving judgment, the Court referred to decisions made in earlier cases where the court had been asked to waive or remedy a defective and invalid administration appointment.

In Re G-Tech Construction Limited (“G-Tech”) and in Re Kaupthing Capital Partners II Master LP (“Master”), the wrong form of Notice of Appointment of an Administrator was used.  In Re Blights Builders Limited (“Re Blights”), an out of Court appointment was made at a time when a winding up petition was in existence (of which the shareholder appointing was unaware) such that the appointment should not have been made. In none of these cases did the Court consider itself able to waive procedural requirements and find that the appointments were, nevertheless, valid.

In Frontsouth, the Court also considered that rule 7.55 could not be used.  Firstly, where an appointment is invalid there are no “insolvency proceedings” and therefore Rule 7.55 has no application.  This reasoning was also applied in Re G-Tech and in Master. The Court also considered that Rule 7.55 was not to be used to remedy a fundamental flaw such as a failure to satisfy a procedure prerequisite for an appointment, thereby rendering a mandatory requirement optional.

In both Frontsouth and Re Blights the Court noted that Rule 7.55 is a strange provision in itself since it suggests that where the invalidity of an appointment causes prejudice, it can be remedied by Court order.

Having had the application to extend the administration refused, the administrators asked the Court to make a back dated administration order and then immediately extend the period of it. 

However, a question arose as to the ability of the administrators to apply for an administration order.  They applied on behalf of the company, in their capacity of shareholders of the company’s parent company (over which they were also appointed as administrators).  However, the company’s Articles of Association provided that the business of the company be conducted by its Directors.  On that basis the Court saw difficulty in making the order on the shareholder’s application.

In any event, an application for an administration order was then made by a qualifying floating charge holder such that the Court did not need to consider the point further.  This issue is, nevertheless, worthy of note, given the decision of the Court in Minmar(929)-v- Freddy Khalatsschi in which an administration appointment made by the directors of the company was considered to be invalid since the decision to appoint was not reached in accordance with the provisions of the Articles of Association.

These cases bring to light the importance of ensuring strict compliance with the Insolvency Act and Rules when making an appointment.  The requirements are mandatory and Rule 7.55 is not a “slip rule” under which mistakes can be remedied.

Security over Principal’s Assets is No Defence to Statutory Demand

In White –v- Davenham Trust Limited, the Court clarified the principle that a statutory demand served upon a guarantor could be set aside, in circumstances where a demand, if made against the principal debtor, could have been set aside.

In this case the debtor was a company.  A debt due to the creditor (D) had been secured by fixed and floating charges over company assets.  The shareholder and director of the company (W) had guaranteed the company’s liabilities. The company went into administration and D wished to rely upon the guarantee to recover sums due from W.  D served a statutory demand on W.

The Insolvency Rules 1986 state that, where a creditor has security over a debtor’s assets for repayment of a debt (and has not waived that security) any statutory demand served should state the full amount of the debt and value of the security and claim only the unsecured balance.  If it does not then the statutory demand may be set aside.

W claimed that, as D could not issue a statutory demand against W, unless it waived its security over the company assets or valued the security, it would be unjust for D to be allowed to proceed with a statutory demand against W.

The Court of Appeal held that a creditor can choose how to recover a debt due to it.  It could pursue a guarantor notwithstanding that it has not pursued the principal debtor.  The existence of security over the principals’ assets did not affect this.  Therefore the statutory demand served upon W would not be set aside.

The Court considered the case of Remblance –v- Octagon Assets Limited where a statutory demand issued against the surety was set aside on the grounds that the principal debtor had a counterclaim that would not have been available to the surety.

In the case of W, the Court considered that a statutory demand could be set aside where there was a dispute that affected the amount claimed, such that the surety’s debt would otherwise be greater than the sum due from the principal debtor.  However, this was not the case here.

Court Refuses Relief for a Transaction at an Undervalue

In Trustee of Gordon Robin Claridge –v- Claridge & Claridge the Court was satisfied that there had been a transaction at an undervalue when a bankrupt husband allowed his wife to use his half share in a loan to renovate her property. However, the Court did not set aside the transaction.

The Judge exercised his discretion on the basis that the bankrupt’s wife had spent the money, thinking that she was entitled to do so and there was no evidence that the renovations had increased the value of the property.

The Court followed the 2007 case of Singla –v- Brown which is authority for the proposition that that the Court has a discretion not to order relief where justice requires it.

The Singla case concerned the purchase of a property in joint names followed by a severing of the joint tenancy and the transfer of 49% of the bankrupt’s interest to the joint owner.  The evidence showed it was always the parties’ intention that the property be owned beneficially by the transferee alone and it was clear that the transfer had been entered into to reflect this intention. The property had been purchased in joint names solely at the insistence of the mortgage company.

The decision in Claridge is likely to come under criticism as this does not appear to be the kind of exceptional case where the Court should use its discretion in this way.  In Singla an order setting aside the transaction would have resulted in an unintended windfall for the bankrupt and his creditors.  This Claridge case does not seem comparable with these facts.

For further information on this article, please contact Pitmans Insolvency & Restructuring team.

Denise Fawcett
Partner
T: +44 (0)207 634 4642
E: dfawcett@pitmans.com

When the long awaited Bribery Act finally came into force on 1 July 2011 most people expected the first prosecution would not commence for many months, if not a year or more and would probably involve a huge bribe.

However, this did not prove to be the case as a humble Magistrates Court Clerk, Mr Munir Patel aged 22, proved to be the first person to be charged and found guilty under the Act for taking £500 to avoid putting details of a traffic summons on a court database. The Judge said the indictment involved at least 53 cases in which he had manipulated the process in order to save the offenders from the consequences of their offending.

Mr Patel was sentenced to three years for bribery and six years for misconduct at Southwark Crown Court.

The severity of the penalty reflects the fact that Mr Patel was in a public office and sends a powerful message to all that no matter how modest the amount of a bribe is the consequences can be very severe.

Alan Davies
Partner
T: +44 (0) 118 957 0300
E: alandavies@pitmans.com

Setting up your first business can be a daunting prospect. However, to help you cut through the red tape when embarking on a business venture of your own – and avoid some common legal mistakes – we explain some of the key issues entrepreneurs are likely to encounter when starting out.

1. Legal structure

One of the first legal points to consider is identifying and setting up the most appropriate legal structure for your business. Typically, small businesses start life as a sole trader business or partnership before being formally incorporated as a limited liability company or limited liability partnership. Usually, the best option for your business will depend on what you are intending to do, and the most-tax efficient way to achieve your aims.

The structure you choose will affect various aspects of how your business is run, such as the type and amount of records and accounts that you will need to keep, and your personal liability if your business runs into financial difficulties. However, even if you intend to operate as a sole trader, it is important to ensure you are registered as such for income tax and national insurance purposes at H M Revenue & Customs. As a first port of call, discuss your circumstances and intentions with an accountant for advice on the most tax-efficient structure for you.

2. Business names

Picking a name for your business is an important first task, but it can also be problematic from a legal perspective. It is important to ensure that your business’s name is not the same as any others (or confusingly similar), and that it does not infringe the registered or unregistered trade marks of any third parties. As well as checking trade mark registers, telephone directories, domain name registries, trade journals and trade magazines, there are a number of online resources, such as Companies House and the National Business Register where checks should also be performed.  As this is a highly specialised area, it is recommended that you use a specialist solicitor to perform these checks.

Be aware, too, that use of certain sensitive words in a business name, such as “institution”, “national” and “society”, are restricted by law and it is an offence to register any of those words as part of a business name without the approval of the Secretary of State. It is also an offence to carry on business under a name using an indicators of legal status to which the business is not entitled, for example, using the word “Limited” at the end of your business name when your business has not been registered as a limited liability company.

Before making your choice, run your shortlist past your solicitor so any issues are identified as early as possible.

3. The key legal agreements

Putting the right legal agreements in place to govern the arrangements between you and the other people involved in running your business, and ensuring that these are tailored to your needs, is essential to keeping your business running as smoothly as possible. The type of agreements that you need will, in part, depend on the legal structure you have selected for your business.

For instance, if you choose a limited liability company structure, a key document for your company will be its Memorandum and Articles of Association, which is essentially a ‘rulebook’ directing how the company operates that must be registered at Companies House (and made available for public inspection). However, you may prefer for certain arrangements between you and any other shareholders that have invested in your company to remain private, and a separate shareholders’ agreement that gives certain powers or rights to certain shareholders may be appropriate (for instance, the owner-manager may require weighted voting rights to ensure they cannot be voted off the board).

If, however, you decide a partnership structure is best for your business and co-investors, then a partnership agreement setting out the rules of how the partnership operates (for example, the share of profits each partner is entitled to) is vital to displace the provisions of the Partnership Act 1890 which would otherwise apply to such arrangements by default – and which may have some undesirable consequences.

4. Terms of business

If your business will provide products or services to third parties, or purchase products or services from others, then it is fairly inevitable that you will be requested to enter into terms and conditions of business with those parties with whom you trade. If any of the terms in those contracts seem unusual or unduly onerous, then seek legal advice prior to signing.

Having your own sets of standard terms prepared, which you can then incorporate into your purchase and supply contracts wherever possible, will put your business in a more advantageous position and ensure it is dealing on the most favourable terms that it can.

You must also ensure that the terms of any contract you enter into are properly documented so that you have a record of your contractual obligations towards your customers and suppliers to refer to in the future. Similarly, if those third parties are not performing their own contractual obligations, ensuring that a copy of the contract is kept on your file will assist you and your advisors in identifying and enforcing the contractual rights available to you.

5. Funding

Broadly speaking, funding falls into two camps: debt finance, where your business borrows money from a third party via loans, mortgages, debentures or invoice discounting, and equity finance, where individuals or other companies invest in your company in return for a share in the ownership of the business.

The options available to you will depend on the circumstances of your business. For instance, in order for a bank to be willing to offer your business a loan, it may require you or your business to own assets of a certain value on which the loan may be secured.

Likewise, the options you decide to pursue will depend on the advantages of the type of financing for your business –debt finance, for example, allows you to retain ownership of your business, but repayments must normally be made on fixed dates which may cause problems if your business’s income stream is unpredictable. In many cases, businesses rely on a mixture of both debt and equity finance.

In all cases, you should carefully agree and document the terms of any financial agreement you make – even (or especially) if it is an informal loan from a relative or friend.

6. Regulatory and compliance issues

The legislative obligations that may apply to your business will really depend on the activities your business undertakes. Some regulations, however, are likely to apply to many trading businesses, such as:

• Sale of Goods Act 1979: which requires you to sell goods of satisfactory quality, that are fit for their purpose and that are as you describe them.

• Sale of Goods and Supply of Services Act 1982: which requires you to perform the services you offer with reasonable care, skill, time and cost.

• Trade Descriptions Act 1972: which makes it a criminal offence to knowingly make false or misleading claims about the goods or services you offer, whether written or verbal.

• Data Protection Act 1998: imposes certain restrictions on the way personal data (such as records of the names of any individuals, including your customers) may be handled, and requires you to register with the Information Commissioner’s Office if you process any personal data (unless an exemption applies).

• Proceeds of Crime Act 2002: which creates the money laundering offences that make it a criminal offence to (amongst other things) conceal, disguise, convert or transfer any property that you know or suspect has been obtained from criminal conduct.

To help you get started, the government’s Business Link website provides information on the rules and regulations that apply to particular sectors. Alternatively, contact a local trade association or representative body for advice. The Trade Association Forum’s directory of UK trade associations is available here.

If you intend to engage contractors, staff or workers, in connection with your business then there will be certain legal obligations with which you must comply. Most importantly, the terms agreed between your business and any employee must be set out in a contract of employment along with certain other pieces of information, such as a job description and details of the place of work, as mandated by section 1 of the Employment Rights Act 1996. Again, the Business Link website covers the basics.

For help with more specific and/or complex regulatory issues, you should consult a solicitor.

7. Property

If you decide to run your business from home, it is important to check your planning permission to ensure that you have the required consents to operate a business from your home address. If you need to apply for additional planning permission, contact your local authority.

However, if you decide to lease or purchase business premises, you will need to agree terms with your landlord or vendor, and ensure you understand the terms on which you intend to contract. There should be a formal agreement in place, and you should seek legal advice on negotiating and documenting the terms of your occupation.

8. Intellectual property

Your intellectual property (often referred to as ‘IP’) comprises not only your business name, but also your confidential information (including know-how and trade secrets), trademarks, copyright, patents, goodwill (that is, the reputation and status attaching to your business, products and services), design rights, domain names… the list goes on. You will need to consider how your IP will be protected and who will own it. For example, you should be aware that IP commissioned by you or created by your employees or directors may not be automatically owned by you. You should take advice from a specialist solicitor on what IP rights you have, or are likely to acquire in the near future (such as IP in new products or know-how created by your employees) and how best to protect those rights.

We wish you every success with your new venture, but if you require any legal advice in relation to these and other issues, we are here to help.

For more information, please visit:

Pitmans’ Corporate legal services

Pitmans’ Commercial legal services

Pitmans’ Intellectual Property legal services

Carolyn Butler
Solicitor, Corporate
T: +44 (0)118 957 0234
E: cbutler@pitmans.com

Andrew Peddie
Partner, Corporate
T: +44 (0)118 957 0321
E: apeddie@pitmans.com

Sally Britton
Partner, Intellectual Property
T: +44 (0)20 7634 4623
E: sbritton@pitmans.com

The Court of Appeal has upheld the decision of the High Court in the matters of Nortel GMBH and Lehman Brothers International (Europe) (both in administration) and other companies.  The High Court had decided that liability under a Contribution Notice issued by the Pensions Regulator against a company in administration or liquidation, in relation to liabilities of a defined benefit pension scheme[1], is an expense[2] of that insolvency process.  Accordingly, the Court of Appeal has confirmed the further extension of the type of expenses that may be considered to have the priority given to an expense of an insolvency process. 

This decision will be of enormous concern to office holders who may find themselves with insufficient funds available, after payment of Contribution Notice liabilities, to fund their own remuneration and to floating charge holders and unsecured creditors who will find the funds available to them to satisfy their claims depleted by the prior satisfaction Contribution Notice obligations.

The liability in question arises out of the provisions of the Pensions Act 2004.  The Act gave the Pensions Regulator (tPR) the power to impose a Financial Support Direction (FSD) upon a company connected and associated[3] with an employer of a defined benefit pension scheme[4].  This power was given to tPR, in particular, to assist the members of an underfunded pension scheme where the employer is a company with no or few assets but is within a group of companies that have assets that the employer has no direct recourse to where the “rich” group companies benefit from the activities of the “poor” employer.  Service companies are specifically referred to in the Act as falling within the reach of tPR but any employer within a group may have the characteristics (of being “insufficiently resourced”) that may expose the rest of the group to becoming a target for tPR’s use of these “moral hazard” powers. 

Companies within the relevant group can be required, by tPR, to provide support to the pension scheme by issuing an FSD against them.  tPR does not specify the support required but this may, for example, be in the form of a guarantee and/or security. If the recipient of an FSD fails to provide support to the pension scheme, then tPR can issue a notice requiring payment of a sum up to the full amount of the pension scheme liability.  This notice is a Contribution Notice.

In the case of Lehman Brothers the liability to the scheme is £125 million.  In Nortel it is £2.1 billion.  An FSD has not yet been issued by tPR in relation to most of the parties to the appeal but Warning Notices setting out tPR’s intention to do so are currently the subject of an appeal to the Upper Tribunal (Tax and Chancery Chamber).

In an administration or liquidation assets are realised and distributed to creditors in an order prescribed by the Insolvency Rules 1986.  Expenses of the insolvency process have priority over other creditors save for those with fixed charges. 

The payment obligation imposed by a Contribution Notice is not stated, in the Pensions Act 2004 nor in insolvency legislation, to be a debt provable in an insolvency process.  The question for the Court was as to whether the obligation is nevertheless provable and, therefore, an unsecured claim or should be treated as an expense of an insolvency process or fall into a “black hole” only being paid in the highly unlikely event that funds are available after payment of expenses, charge holders and unsecured creditors.

A provable debt is one which a company is subject to at the date of liquidation or may become subject to pursuant to an obligation arising before that date[5]. 

The types of payments becoming due, in the course of an administration, that are treated as expenses has been clarified and some would say extended through case law, from Toshoku[6] in 2002 to Goldacre (Offices) Ltd –v- Nortel Networks UK Ltd[7] in 2009. In the latter case it was decided that rent obligations of a company, although obligations of the company subject to lease entered into prior to its administration, would be an expense of an administration if they fell due during the process and whilst the administrators were deemed to be using the premises for the purpose of the administration.

Before the High Court, it had been determined that, in certain situations, a Contribution Notice would be provable in an insolvency process.  This would be the case where an FSD was issued in an administration of a company and a Contribution Notice followed after the company had moved from administration into liquidation or if the Contribution Notice followed the FSD and the company then moved into liquidation.  The Contribution Notice would arise in the liquidation from a pre-existing obligation and was therefore a provable debt in the liquidation but not the administration.  This was not the subject of the appeal.

The appeal was around the issue of categorising the Contribution Notice liability where liquidation does not follow the administration or liquidation does follow but the FSD and Contribution Notice are issued in the liquidation and not the prior administration.  The High Court held that the Contribution Notice would, in these circumstances, be treated as an expense giving the obligation under it “super priority”.  In the appeal the Nortel administrators argued that the liability was a provable debt.  The Lehman administrators argued that it fell into a black hole.

The High Court and the Court of Appeal considered whether the fact that an FSD may arise from circumstances that exist prior to any insolvency process meant that the resulting Contribution Notice was a contingent claim in existence at the time of the insolvency, rendering it a provable debt.  Both Courts found that it did not.  It was considered that there was insufficient certainty that tPR would use its discretionary powers to render a company liable for an obligation to a pension scheme that, up until its powers were invoked, only the employer company could have been liable for.  The Court of Appeal did not consider whether the obligation could have arisen earlier than upon the issue of an FSD, for example, at the time that tPR’s Determinations Panel determines that the FSD should be issued or upon the earlier issue of a Warning Notice.

Having decided that a Contribution Notice did not, when issued against a company in administration or liquidation, create a provable debt in that process, the Court was left with a choice of either deciding that the obligation created had super-priority and therefore greater priority than the scheme debt held as against the employer or was neither a debt nor an expense and therefore had lower priority than the scheme debt held.  Neither the High Court nor the Court of Appeal considered either conclusion to be satisfactory, particularly when comparing the purpose of an FSD and Contribution Notice i.e. protecting scheme members, against the competing interests of unsecured creditors. 

Both Courts considered that the position as decided in Toshoku was to be applied to the circumstances before them.  In Toshoku the Court found that tax liabilities imposed by statute were  an expense of an insolvency process where the relevant statute specifically intended and provided that the obligation would be imposed upon a company in insolvency.  In Nortel and Lehman it was acknowledged that the Pensions Act 2004 did no such thing and left it to insolvency law to determine the priority of a Contribution Notice.  However, it was considered to be highly likely that that the regime would be used in the case of an insolvent employer and a real risk that other potential targets in the group would also be insolvent at the time that tPR came to use its powers.  For that reason the obligations of a company under a Contribution Notice imposed upon it whilst in an insolvency process is an expense of that process.

Office holders of group companies in the same situation will need to consider applying to the Court for an order varying the order of priority of expenses or face difficult decisions as to how to progress an insolvency where office holder remuneration and expenses may not be paid.  It was acknowledged by the High Court that, unless the order in which expenses are to be discharged is varied by the Court, the decision in this case could deal a crippling blow to the rescue culture in cases where defined benefit pension schemes are involved.

Financiers will need to factor into lending decisions the possibility of substantial liabilities, not shown on a company’s balance sheet that would, if they arose, have priority over lending secured by a floating charge and all unsecured lending.

The main beneficiary of this decision is likely to be the Pension Protection Fund (PPF), the government’s lifeboat for pension funds which would otherwise foot the bill for underfunded schemes with an insolvent employer.
 
It is expected that the decision will be appealed to the Supreme Court.  Various sector groups will continue to lobby for a change to pensions and/or insolvency legislation.  The government will have a difficult policy decision to make, supporting business and the rescue culture or pension scheme members and the PPF.  For now, its pension schemes 1 – business and rescue culture 0.

Denise Fawcett
Partner
T: 020 7634 4642
E: dfawcett@pitmans.com

1 A defined benefit pension scheme (or final salary scheme) is a benefits funding method in which the liability to the scheme is based on the benefits that would arise if the scheme were to be discontinued on the valuation date and the contribution rate is that necessary to cover the cost of benefit payments due.
2 Expenses are defined in Rule 12.2(1) of the Insolvency Rules 1986. Also see Rule 4.218 Insolvency Rules 1986 in relation to liquidation expenses and Rule 2.67 Insolvency Rules 1986 in relation to administration expenses.
3 Sections 249 and 435 Insolvency Act 1986.
4 Note that an FSD can also be imposed upon the employer itself.
5 Rule 13.12 Insolvency Rules 1986.
6 Re Toshoku Finance UK Plc [2002] UKHL 6, [2002] 1 WLR 671
7 [2009] EWHC 3389 (Ch), [2010]Ch 455

Head of Corporate at Pitmans LLP, Andrew Peddie, welcomes the recent Government announcement of a new Enterprise Zone in South Oxfordshire.  Called Science Vale UK, it brings together the Milton Park and Harwell Campus sites under one umbrella to further encourage innovation and business growth in the region. 

“Milton Park and Harwell Campus already contain a significant cluster of growing high-technology companies.  The Government’s new Enterprise Zone initiative is aimed at further encouraging growth at locations all around the country where there are existing hubs for such businesses.  While the figures for the anticipated growth in jobs and development resulting are not enormous at this stage, there is no doubt that continued investment in the UK’s science, technology and design base is a key factor in the success of the national economy.  As a region, the Thames Valley must continue to be at the forefront of the knowledge economy, and this initiative should help that to happen.

Alongside its strong science based businesses, the Thames Valley is well served by professional services businesses with a real understanding of the issues of importance to those companies.  Intellectual property protection is the key in this context and Pitmans continues to grow its capabilities rapidly in this area.  If you are a growing company in need of support in protecting your key assets (IP or otherwise), come and speak to one of our experts.”

Andrew Peddie
Partner
+44 (0)118 957 03221
apeddie@pitmans.com

Retailers Take Note: Data Privacy Trends and Actions for the coming year: Highlights of the Information Commissioner’s Annual Report 2010/11

If the idea of digesting the Information Commissioner’s 86-page long annual report in full doesn’t really appeal to you, then why not let us do the hard work? Below, we highlight not only the key changes to the policy and enforcement objectives of the Information Commissioner’s Office (“ICO”) over the past year, and the likely indications from the report of the developments to come, but also our suggested actions and comment to help you avoid falling foul of data privacy compliance, risking damage to your reputation and incurring unnecessary cost and resource further down the line.

New powers

The ICO’s enforcement arsenal was enhanced significantly in April 2010 when it was granted the power to fine organisations up to £500,000 for serious breaches of the Data Protection Act. Four monetary penalties have been issued since then, as well as five prosecutions brought in the last year. However, the ICO has been keen to stress that such tactics are a means of last resort, and seeks to resolve cases informally where there is opportunity to do so.

Pitmans Comment; it is worth noting that since May 2011 the ICO now also has the power to fine organisations up to £500,000 for serious breaches of the Privacy and Electronic Communications (EC Directive) Regulations 2003 (the previous power to fine only extended to serious data breaches, not breaches of the laws relating to electronic marketing and privacy).

In addition, the ICO also has a new power to audit measures taken by a public electronic communications service provider (service provider) to:

• safeguard the security of its service; and
 
• comply with a new personal data breach notification and recording requirement.

This second requirement is a significant development and, where a breach may adversely affect the personal data or privacy of a user, a service provider is not only obliged to notify the ICO, but also the user concerned. This has a significant cost and PR implication.

The ICO favours prevention over cure; it tends to accept undertakings (where an organisation commits to making specific improvements) as a precursor to more formal action. The number of instances where the ICO has approached organisations to offer good practice audits has increased dramatically over the past year, although take-up in the private sector has been poor. Nevertheless, the ICO issued 26 audits in 2009/10, 60% more than in 2009/10. It also released several codes of practice last year to help businesses stay on the straight and narrow, including a Code of Practice on Personal Information Online which was launched in June.

Pitmans Suggested Action: ensure you have a paper trail evidencing compliance and training. Refresh staff by periodic training and regular security reviews and conduct vulnerability testing to public accessing applications. It is clear that audits are becoming more popular. Always be prepared.

Emerging enforcement trends

The hot topics

Subject access requests were the most popular topic of complaint, accounting for nearly a third (28%) of all issues reported to the ICO. Since this is the area where, statistically, data controllers tend to slip up, companies are well advised to ensure they have appropriate systems in place to deal with subject access requests within the applicable time limits. Inaccurate data (15%), inappropriate disclosure of data (12%), and automated and live marketing calls (9% each) are the cause of the next most numerous complaints. There has also been an increase of 17% in the number of freedom of information cases referred to the ICO over the past year.

The ICO has earmarked the challenges perpetuated by (or, indeed, in spite of) technological advances as a priority. The ICO is concerned that a significant amount of highly sensitive personal data is still sent by fax, despite the securer alternatives offered by newer technology. Failures by organisations to encrypt personal data in appropriate circumstances remain also remain a key concern.

The new rules in relation to cookies are also firmly on the agenda. Although the lead-in period for the new rules expires in May 2012; the ICO has indicated that it will intervene in the meantime in certain circumstances: “we shall hold our enforcement powers in reserve, intervening in the first year only where it is clear that a website owner is doing little to attempt to comply”.

Pitmans Suggested Action: review what technical and operational security measures your organisation currently employs in relation to sending personal data and keeping data secure. If your staff are using mobile devices and laptops, review and implement encryption software solutions.

Companies would also be well advised, if they have not already done so, to conduct a digital marketing audit and review their data processing and collecting practises in the e-commerce environment. Please let us know if you would like assistance with such an audit.

The targeted organisations

Essentially, the ICO targets those organisations about which it receives the most complaints. The ICO affirmed that it also uses a risk-based process to identify and contact organisations that handle personal information, which takes into account a number of factors such as volume and type of data an organisation holds, complaints received by the ICO and cases where enforcement action was considered. It then uses the information from individual cases to build a picture of how seriously data controllers take the issue of handling personal data or providing information the public has a right to see.

The ICO has declared that it now expects more from data controllers when complaints are reported – as well as asking them to explain the circumstances of individual complaints, it now asks for information about how the data controller intends to put things right and how they adhere to general information rights obligations.

Pitmans Suggested Action: respond to complaints and proactively manage any inappropriate use of personal data carefully. Consider preparing a contingency response plan to any complaints, with a pre-prepared response to customers, the ICO and the press.

The targeted sectors

Over the past year, the ICO launched campaigns aimed at estate agents and private medical practitioners to remind them of their obligations to notify the ICO if they handle personal data. Accordingly, we should probably expect similar campaigns in the future directed at other industries in the private sector that routinely handle personal data, e.g. education and training providers, telecoms companies, and online retailers.

Pitmans Suggested Action: retailers, in particular, take note. The ICO issued a statement on 9 August in the light of a security breach suffered by Lush, the cosmetics retailer, making it clear that etailers must ensure they keep customers’ personal data secure. An extract of the statement is reproduced below: -

Acting Head of Enforcement at the ICO, Sally Anne Poole said:

“With over 31 million people having shopped online last year, retailers must recognise the value of the information they hold and that their websites are a potential target for criminals.
 
“Lush took some steps to protect their customers’ data but failed to do regular security checks and did not fully meet industry standards relating to card payment security. Had they done this, it may have prevented the fraud taking place and could have saved the victims a great deal of worry and time invested in claiming their money back. This breach should serve as a warning to all retailers that online security must be taken seriously and that the Payment Card Industry Data Security Standard or an equivalent must be followed at all times.”

In the meantime, the ICO will be consulting on a revised Information Rights Strategy showing how it prioritises the different sectors and subjects for regulatory attention, which is definitely a development to watch out for!

The likely consequences

The ICO’s report contains a selection of salutary tales demonstrating exactly how not to deal with a data protection breach. These case studies indicate the circumstances that the ICO is likely to consider as “aggravating factors” when determining whether to issue monetary penalties. As well as the impact and severity of breach the ICO will consider a number of factors, such as whether:

• a risk assessment was made;
• alternative means of storing/transmitting data were considered/devised;
• other measures were employed to minimise risks (e.g. by using a ‘ring ahead’ system to increase security of fax transmissions);
• the organisation followed its own policies;
• effective remedial action was taken following the breach (such as the re-training of staff);
• the organisation’s officers and staff understand the cause and significance of the breach.

Pitmans Suggested Action: conduct Privacy Impact Assessments (PIA) and employ Privacy by Design (PbD) into concept and new product design to ensure that any privacy implications of new technologies are considered at an early stage. This may reduce the likelihood of incurring substantial re-development costs at a later stage, as well as the risk of complaint, adverse PR and enforcement.

Improved efficiencies

The number of decision notices issued by the ICO increased significantly from 628 in 2009/10 to 817 in 2010/11, However, the appeal rate has remained constant at around 25%, meaning, effectively, that there has been no corresponding deterioration in the quality of decision making. The ICO has put this dramatic improvement down to the introduction of new structures and processes that has allowed it to deal more quickly with complaints.

There has also been a blitz on freedom of information complaints. Over the last 12 months, the number of complaints that have been in the ICO’s in-tray for more than a year has reduced from 117 complaints to just three.

Involvement in law making

In terms of the ICO’s contributions to UK legal policy, it has had a busy year. The ICO issued responses in December 2010 and February 2011 to the Protection of Freedoms Bill, and provided evidence to the Public Bill Committee in March 2011. Also in December last year, the ICO issued a statement welcoming proposals set out by the government to expand the scope of the Freedom of Information Act.

At present, the ICO is engaged in the review of the OECD’s Privacy Framework and modernisation of the Council of Europe’s Data Protection Convention, and, through its membership of the Article 29 Working Party, the ICO is also reviewing the EU Data Protection Directive. The ICO will also be contributing to the post-legislative scrutiny of the Freedom of Information Act by the House of Commons Justice Committee.

This year, the ICO appointed Simon Rice, who has a background in delivering databases, software tools and data analyses for a government research agency, as the ICO’s first technology policy advisor to assist with the work on policy development, investigations and complaints handling. Simon’s appointment is complemented by the creation of a Technology Adviser Panel, whose role is to assist the ICO in producing up-to-date, relevant guidance on technical innovation and up-and-coming issues.

Pitmans Suggested Action: technology providers and organisations using new technologies to gather and analyse and mine user profiling data beware. The ICO is investing more in analysing new technologies and is likely to be more savvy in its enforcement of non-compliant data repositories and applications. Again, consider privacy at an early stage of design and development and, before licensing a new CRM system or data tool, ask the relevant supplier to confirm what steps it has taken to ensure that it complies with data privacy laws (whether it be at home or abroad).

For further information regarding Pitmans Intellectual Property  team, please contact:

Philip James
Partner
+44 (0)207 634 4655
pjames@pitmans.com

Carolyn Butler
Solicitor
+44 (0)118 957 0234
cbutler@pitmans.com

In the rapidly developing arena of internet regulation, law-makers and industry leaders the world over are grappling with the issue of “net neutrality” whether internet service providers (ISPs) should be permitted (or, indeed, required) to manage internet traffic according to its type and size, or whether all networks should be “neutral”.  While some governments, such as the Dutch and Chilean governments, have passed regulations that mandate net neutrality, other countries believe that heavy-handed regulation will stifle innovation and growth. This article examines some of the arguments from both sides and looks at the status of this issue in the UK – in particular whether the UK is likely to legislate on this issue or not.

What are the arguments?

The “pro-neutrality” side of the debate believes that all internet traffic, from bandwidth-heavy high-definition videos to basic emails, should be treated equally by ISPs and permitted to travel across the internet at equal speed. The primary concern is that any attempt to disrupt the free flow of traffic (by authorising ISPs to block or otherwise manage content) would harm what they see as the primary characteristics of the internet. This could ultimately lead to “big-brother” censorship, where ISPs prioritise content from heavyweight service providers offering video on demand services, such as Sky Anytime, or online gaming, such as Nintendo or Sony, who may have the resources, and be prepared, to pay ISPs for special treatment.

The alternative view is that the internet services to which consumers have grown accustomed can only continue to be delivered with effective “traffic management” that necessarily favours some content over others. It is claimed that the extra bandwidth consumed by increasingly sophisticated services (for example, online multiplayer gaming and voice-over-internet services), has congested networks and intensified the strain on the internet’s infrastructure, resulting in lower transmission speeds for all. Proponents of this view, generally the ISPs themselves, argue that the prohibition on differentiating between types of network traffic will make it harder for them to cater to what they perceive as a genuine consumer need for such services, for instance, for uninterrupted, high-definition video and music streaming and effective security measures (such as parental controls). 

International policy developments

Last month, the Netherlands became the first EU member state to introduce laws to protect the neutrality of its networks (following Chile’s introduction of similar measures in May).  In the United States, the Federal Communications Commission (FCC) will shortly publish net neutrality rules in the Federal Register, which are likely to take effect in the autumn. The FCC’s view is that while, in the past, “broadband providers endanger the Internet’s openness by blocking or degrading content and applications without disclosing their practices to end users”, basic standards for conduct by ISPs are necessary to ensure the internet’s continued openness.

The Council of Europe agrees, and has drafted a set of Internet Governance Principles stating that “openness, interoperability and end-to-end nature [of the internet] should be preserved [and] should guide all stakeholders in their decisions related to internet governance”. The Council is firmly of the view that “any traffic management measure or privilege should be non-discriminatory, justified by overriding public interest, and must meet the requirements of international law on the protection of freedom of expression and access to information”.

In the UK, the Communications Minister, Ed Vaizey, has stated his preference for industry to lead the way in developing the UK’s policy on net neutrality, and for a light-touch approach to regulation. Speaking at the Intellect 2011 Consumer Electronics Conference this month, he argued that any regulatory framework implemented “must be dynamic and flexible enough to keep up with the pace of change we are seeing in these markets”.

In order to determine what such a regulatory framework may look like, the UK communications regulator, Ofcom, launched a public consultation on traffic management and net neutrality last summer, which led to spirited responses from industry leaders and interest groups alike on both sides of the discussion. Further details on the consultation may be found here.

Consumer Interests

The main themes to emerge from Ofcom’s consultation were the need to (i) protect consumers and (ii) promote and maintain effective competition in the market for broadband service providers.

Consumers are best served by transparency and the appropriate disclosure of information relating to the services provided. Consumers must have sufficient, comparable information to make informed choices when selecting an ISP and to vote with their feet if they wish to change ISPs (e.g. if their current ISP interferes with or downgrades their broadband service to an unacceptable degree). Where ISPs are not willing to disclose information about the performance of their services to their users, some content providers (especially those that may be disadvantaged if forced to pay a premium for network priority) have indicated that they will. For instance, in November the BBC suggested adding software to the BBC iPlayer to indicate to users whether the user’s ISP had degraded their service leading to poor-quality video streaming, the idea being to pressurise ISPs into foregoing the prioritisation of traffic.  

The presence of a number of suppliers in the market does not necessarily guarantee effective competition at the consumer’s level. The US broadband market, for example, is effectively a relatively uncompetitive oligopoly and in those circumstances it is easier to justify regulation to protect consumers, since there is very little that consumers can do to either drive down prices or raise the quality of services offered to them. While consumers have greater choice of suppliers in the UK, a lack of information may make it challenging for consumers to distinguish between the services offered by different ISPs and to switch ISPs if they are not satisfied with the level of service – thereby reducing the beneficial effects of having, technically, a price-competitive market.

However, in its response to the consultation, the Communications Consumer Panel, an independent advisory body established under the Communications Act 2003, pointed out that very little research is available (from the UK or elsewhere) that analyses consumers’  decision-making about broadband services or the extent to which consumers understand the information provided to them by the relevant ISPs about such services. In order to identify what the regulatory framework hopes to achieve, it will first be necessary to identify, by undertaking research into consumers’ understanding of traffic management and their behaviour surrounding the selection of broadband services, the issues that need to be addressed by it.

UK: is regulation on the way?

The prevailing mood in the UK seems to be in favour of light-touch or self regulation, where ISPs govern themselves, to ensure the fair application of net neutrality principles as a pragmatic alternative to introducing proscriptive regulations that the industry is likely to rapidly outgrow.

There is a clear commercial incentive for ISPs to prioritise certain content in exchange for fees from the provider in question. If voluntary codes and competitive forces are not sufficient to check practices such as prioritising content transmission from certain sources, regulation may be the only answer.

If you would like further information on the above article, please contact Carolyn Butler or Rustam Roy.

Courtesy of the Thames Valley Business Magazine July/August 2011.

It has become increasingly commonplace for commentators to cast doubt on the effectiveness of the AIM market.  Since the start of the current financial turmoil, prior to which the number of new entrants to the market boomed, there has been a significant slump in primary issues and fundraisings on AIM.  This has of course coincided with a downturn in the global economy and the resulting drain on the cash available for investment in the UK, but does the problem run deeper than that?

When AIM was launched in 1995 it sought to provide a platform for smaller and growing companies, providing them with liquidity and access to capital on a global scale.  This made AIM a very popular choice for small and medium sized companies looking for growth and for investors looking for an exit route. Over the last 15 years the success of the AIM market has shown why it is important to have a strong, functioning junior stock market in the UK and it has become a model for other stock markets across the financial world. 

Most growing companies reach a point in their development when they need access to more capital.  Frequently they will turn to venture capital or private equity funding to obtain it.  Any such investors typically will be looking to exit that investment in a three to five year timescale, often dictated by the lifespan of the funds which they in turn have raised from external investors.  Although the growth of a secondary and tertiary buy out market over the years has meant that has become a very serious alternative, and a trade sale to a competitor is in many cases another option, an IPO onto AIM or the full list is one of the classic exit routes. 

If this IPO exit route is increasingly closed out, it reduces the exit options for those investors.  Given how important the financial investor sector has been to the UK economy over the last two decades, this in itself is a reason to try to address some of the problems that AIM has been experiencing.  It is even more pressing because of the issues that currently dog the debt funding market.  As we know, many banks (both UK and international) are busy focusing on strengthening their own balance sheets following the 2008 credit crisis (and given the sovereign debt risk that is still out there in much of Europe) rather than on new lending to corporates.  Therefore, the number of avenues for corporates to seek new capital to grow their businesses is further reduced. 

So what has gone wrong and why have we seen an increase trend in de-listings and alternative investment routes? In some ways AIM has been a victim of its own success. Sold on a brochure of lighter regulation, access to international investors providing increased visibility and profile and the badge of being a listed company, entrants to market have not been hard to find in the good times.  Now that investment capital is limited, is the market is self regulating the quality of successful applicants as investors become more selective or cautious about where they invest their money? Is there a danger that this self regulation will disappear when the equity taps begin to open again and how should this be addressed? Alternatively is it the cost of regulation that is putting off growth companies these days from going down the IPO route?

More emphatic regulation by the London Stock Exchange both of AIM market companies and their Nominated Advisors would be welcomed in some quarters to counteract any reputational damage sustained over recent years and further improve the quality of market applicants.  In order to achieve this any such regulation could make it harder to get an inappropriate company onto the market, or make the consequences for failures to meet minimum standards more severe.  The fear amongst the investment community is however that over regulation may strike at the heart of what AIM is about and further dampen the appetites for IPOs.  

Whilst greater regulation is a cornerstone of a sound financial market, it is unlikely to address all of the issues currently facing AIM. There has been some discussion as to whether the UK Government should give further tax incentives to those making AIM investments.  While this seems unlikely in the current economic climate, encouraging a broader mix of investors into AIM, which is still dominated by investment funds, would certainly be likely to increase the range of investors and liquidity in the market generally, thereby reviving the market. 

Whilst it is true that if nothing is done to turn the AIM market around, it may continue to slide in popularity and that would be to the detriment of UK industry, particularly at the medium sized company level, many of the problems faced by AIM are not of its own doing and the solution should not be found in tinkering with the market. Medium sized companies need access to long term, reliable sources of capital.  The absence in the UK of a banking system like the German regional banks, who support these types of companies over the long run, means companies, who are not FTSE 350 size, but have long outgrown friends and family and business angel funding, do need a functioning junior public market as an alternative.  Regulation coupled with tax breaks can be a good thing where market regulation fails, but on their own they will not change market sentiments. Confidence is slowly returning and advisors are reporting an upturn in AIM related instructions. Now is the time for investors in AIM to lead the way, allowing medium sized companies to access capital, grow and succeed, providing confidence to other sectors in the economy. Of course we could just create a new regional banking structure – but that is another challenge altogether.

If you would like to know more information about this article, then please contact either Andrew Peddie or Daniel Jacob of our corporate team.