Finance Industry Update April 2010
Subsidiary concerns
In the recent case of Enviroco Ltd v Farstad Supply A/S 2009, the Court of Appeal found that a much-used definition from the Companies Acts is defective in relation to the definition of 'subsidiary' used in the Companies Act 1985. This article examines the case more closely and looks at potential options going forward in order to avoid the situation that arose in the case of Enviroco.
In general, a Scots law share pledge requires perfection for the chargee to hold effective security – that means that the shares are transferred over to the chargee (or its nominee), with its name being entered in the Register of Members. However such a transfer is made in security only – the terms of the pledge will state this, the Companies Acts acknowledge this and the Register of Members ought to reflect this. Voting rights and dividends usually remain with the charging company until an enforcement event occurs. This of course differs from the approach in England, where a lender will often rely on an equitable charge whereby no transfer takes place until an enforcement event occurs.
The facts of the Enviroco case itself are complicated – essentially, it involved a dispute over the scope of an indemnity which turned on the definition of 'affiliate' in a charterparty. 'Affiliate' was defined by reference to 'subsidiary' which was in turn defined by reference to the 1985 Act (and now reflected in the Companies Act 2006). The relevant section provides three alternative tests of control of a subsidiary, two of which require that the holding company be 'a member of' the subsidiary, which means it must be registered into the subsidiary’s Register of Members.
In fact, the shares in question had been pledged to a lender, while an additional complication was that the chargor, Asco, did not in fact hold more than 50% of the voting rights in Enviroco although it did control more than 50% of the voting rights. That meant it did not comply with the first of the three tests relating to holding a majority of voting rights.
The lender, Farstad, was duly entered onto the share register of Enviroco pursuant to the share pledge. The question was whether Enviroco was still a subsidiary of Asco, a question which the Court of Appeal answered in the negative.
It concluded that membership of a company was not one of the rights attached to shares, which comprised voting rights and rights to appoint or remove directors etc. It was instead a status derived from being entered in the Register of Members. Membership is a question of fact – if company A is not a member of Company B (i.e. it does not appear on its Register of Members), it cannot be the holding company of company B under the Companies Acts. Had Asco, however, held more than 50% of the voting rights (rather than merely controlling them), it would have maintained ‘holding company’ status.
Given that the statutory definition of ‘subsidiary’ is used so often as a catch-all in legal documents, it is easy to see why this decision could be so far-reaching…
Would an inter-group guarantee still catch each ‘subsidiary’ company if those shares are pledged? Could a company’s tax-grouping for VAT be affected? What about financial covenants and change of control provisions which are found as a matter of course in facility agreements and related security?
So what can be done?
It is important to note that Enviroco have been granted leave to appeal to the Supreme Court so this may not be the final word on the matter. Also, it is not exactly typical for a charging company to hold less than 50% of the voting rights in its subsidiary, although this may arise in joint venture situations.
Lenders should also take heart that, in the scenario that a bank was deemed a ‘holding company’, the charged company wouldn’t become part of its grouping for accounting or tax purposes provided the pledge states that prior to enforcement, any rights under the shares are exercisable only in accordance with the instructions of the chargor (which is the norm).
In the meantime, care should be taken when dealing with parent / subsidiary finance arrangements.
Contracts that refer to the statutory definition of subsidiary should be amended to correct this technical error, with the typical ‘subsidiary’ and ‘holding company’ definitions in finance documents tightened. Meanwhile any existing provisions should be reviewed and redrafted to bind charged companies, so that the effect of a transfer of legal title to shares or the perfection of security interests in shares, is not at odds with the parties’ understanding in relation to an ongoing parent and subsidiary relationship.
Enforcing guarantees – what’s the debt?
A recent case in the Court of Session (Maureen McLaughlin v Anglo Irish, 26 March 2010) considered whether or not the completion of a certificate of indebtedness should be a precondition to summary diligence against a guarantor.
Park Circus Homes (Glasgow) Limited were provided with banking facilities by Anglo Irish Bank. Joint and several personal guarantees securing the finance to the company were provided, subject to a cap of £2 million. The company began to suffer financially and a demand for repayment of the facilities was issued. No repayment was forthcoming and the company was in due course placed into administration.
The personal guarantee granted by Maureen McLaughlin was registerable for preservation and execution. This meant that the guarantee could be enforced by summary diligence and allows a document of debt – in this case, the guarantee – to be treated as the equivalent of a Court decree, meaning that the costs and delay of suing for a debt can be skipped, and the creditor can proceed straight to enforcement.
Following registration of the guarantee, the bank issued a letter demanding repayment of the full £2 million plus costs and interest, which expired without payment. The Bank proceeded to serve a charge for payment to establish insolvency, and proceeded to lodge a petition for sequestration.
In response, the Guarantor raised proceedings in the Court of Session for suspension of the charge and interdict against sequestration. The Court granted interim interdict in the meantime, and a full hearing on the matter was fixed. At that hearing, the Guarantor’s petition was dismissed, but she appealed the decision.
The issue before the Court revolved around the failure of Anglo to provide a certificate of indebtedness when registering the guarantee for preservation and execution. It is common to find a provision in guarantees that a certificate of indebtedness signed by the bank is sufficient to ascertain the debt and put the matter beyond doubt.
The Guarantor argued that such a certificate was a precondition to enforcement, while Anglo argued that the demand letter setting out the sum due was sufficient. The Court found that no general rule applied but that matters turned on the wording of the guarantee as to whether or not a certificate ascertaining the sum due was necessary.
On considering the wording, the Court found that all that was required was a written demand, and that the certificate was intended to deal with the situation where on receipt of a demand, the Guarantor disputes the amount due.
The case also considered a meeting at which the guarantor alleged that Anglo had advised that if the company went into administration, the guarantee would not be called up. The Guarantor argued that Anglo were personally barred as a result from calling up the guarantee.
Anglo disputed this, but nevertheless cited a clause in the guarantee which provided that the guarantor contracts out of waiver. The Guarantor then sought to argue that the meeting constituted a variation of the contract, but the Court found that this would have had to be in writing. However, the Court was not of the view that the no-waiver clause was a complete answer to the issue, and fixed a proof before answer on the issues of waiver and of personal bar.
While the case assists in determining that in most cases, a certificate of indebtedness is not a pre-requisite to the enforcement of a guarantee, it’s a reminder that the specific wording of the guarantee should be checked in each case to avoid any prospect of an expensive oversight.
The case also serves as a useful reminder to be careful when dealing with guarantors on the insolvency of the principal, and to be careful not to give any kind of assurance about the enforcement or otherwise of guarantees.
A firm foundation for collateral warranties
In the recent cases of Scottish Widows Services Limited v Harmon/CRM Facades Limited & Ors, and Scottish Widows Services Limited v Kershaw Mechanical Services Limited & Ors [2010] ScotCS CSOH 42, the Court of Session issued an opinion relating to two separate actions arising out of the construction of the Scottish Widows HQ at Port Hamilton, on Morrison Street, Edinburgh, during the late 1990s. Scottish Widows sought to enforce certain collateral warranties granted by various contractors which had been assigned in its favour in 2003.
Collateral warranties are of course a common requirement in development funding, seeking to give the funder a right of recourse should any issues arise in the course of construction. They are designed to ensure that the party who actually suffers the loss is the one who has a right of action against the party who caused such loss, whether or not they otherwise have a direct contractual relationship.
Lord Drummond Young considered various arguments before allowing the case to move to proof before answer, the main emphasis of which was the Court’s opinion that collateral warranties are an ‘important feature of modern practice in the construction industry’, and ought to be ‘construed in such a way as to further their essential purpose, namely to ensure that the party who suffers loss has a right of action against any contractor or member of the professional team who has provided defective work.’ Therefore, it is important to look at the parties’ commercial intentions behind the grant of the warranty.
It was suggested that a net contribution clause (whereby joint and several liability may be restricted to a commensurate assessment of the actual loss caused by each party) may be enforced in line with market expectations, albeit it was not for the Court to consider this at this stage in the case.
The Court observed that the physical defect in the building is itself the primary loss, though it may have economic consequences for many parties (i.e. the cost of repairs). That liability for repairs is also a loss, and the party incurring such loss ought to be able to sue to recover it. It also does not matter whether the party is obliged to carry out any necessary repairs under the terms of a lease or otherwise – it is the fact that they have been carried out at the beneficiary’s expense that gives rise to a claim.
In relation to the potential situation where many beneficiaries may have a claim for the same defect, the Court agreed that this may be a problem requiring a solution, but in practice it may be easily dealt with so as to avoid ‘double recovery’.
It was also considered whether an architect might have a liability to a beneficiary (or to its original client), for failing to appoint a specialist sub-consultant, when it did not have the in-house expertise to fulfil a function required of it under its professional appointment.
Overall, it is heartening to see that the Court of Session has taken a pragmatic view of the arguments presented in this case, with an overall nod to the commercial intentions and current market practice used within the construction industry. From a funder’s point of view, it gives judicial support to the rights of a beneficiary under a collateral warranty to rely on the terms of that warranty, particularly in terms of loss suffered.
The language of insolvency – when is an administration a winding up?
In a recent case arising out of the Kaupthing Singer & Friedlander administration, an interesting point on the meaning of the phrase 'winding up' in a document of debt was determined.
The issue cropped up when dealing with the company’s unsecured creditors. In an administration, the administrators are entitled to adjudicate on and pay out claims of secured and preferential creditors. To do the same for unsecured creditors, however, administrators require the authority of the Court.
Settling the claims of unsecured creditors in an administration means that a subsequent liquidation is not necessary, thus providing cost benefits to all involved. Indeed, this allows all the company’s creditors to be dealt with under the one insolvency regime, after which the company can move straight to dissolution.
Here, the administrators sought authority from the Court to deal with unsecured creditors, which was granted. The administrators were then faced with a specific ranking issue, on which they sought guidance from the Court on the treatment of the claims of subordinated bond-holders.
The document of debt provided that the rights and claims of the bond-holders would be subordinated on a winding-up. The question before the Court then was whether a distribution to unsecured creditors in an administration was equivalent to a liquidation, such that the subordination provisions of the bond would kick in.
The administrators argued that 'winding up' in this context included both voluntary and compulsory liquidation, together with administrations where a notice of proposed distribution to creditors has been given. The Court considered 'winding up' as a term of art and found that in the context of the document of debt, it was intended by the parties that the debt be subordinated on insolvency. The Court found that here, administration was equivalent to a winding up, and that it was unnecessary for the company to be placed into liquidation for the wording to take effect.
While this is a welcome pragmatic approach by the Courts, and provides some comfort for those with similarly drafted documents, the Courts do not always take such a line.
Indeed, in a construction contract case decided earlier this year (William Hare Limited v Shepherd Construction Limited and CR Reynolds (Construction) Limited v Shepherd Construction Limited [2010] EWCA Civ 283), the Court found that reference to the ‘old-style’ administration – i.e. pre-Enterprise Act 2002 – as an event of insolvency did not include new out of Court administrations. The contractor had intended to use a pay-when-paid defence, given that the employer was insolvent. However, due to the out-of-date referencing in the contract, he was unable to do so.
So that documents of debt are enforceable in the correct circumstances, it is therefore advisable to ensure that insolvency provisions are correctly drafted, to take into account changes in legislation and in practice. While it would be hoped that the Courts will take a pragmatic approach, the risk remains that a strict interpretation can be costly.
Registration of charges
The Department for Business Innovation and Skills (BIS) issued a consultation paper on 12 March regarding potential amendments to the current regime for the registration of charges created by companies and limited liability partnerships. Some of the key issues that BIS are consulting on include:
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the removal of the 21 day time limit for registration, and the consequences of registration and failure to register;
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what type of charge should be registrable;
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the registration procedure, including the possibility of electronic registration of security interests; and
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whether registration of security interests in a specialist register (such as at the Land Register) might be treated as registration of that security interest at Companies House.
The 21 day period
Clearly, the most radical proposal is the removal of the 21 day period for registration of charges. At present, if a registrable charge is not registered within 21 days of creation then it is void against any liquidator, administrator or creditor of the company (the ‘sanction of invalidity’) and an offence is committed by the company and each of its officers in default. It is proposed that, instead, an unregistered charge would still be void against any liquidator, administrator or creditor of the company, but also void against any existing charge (save for a floating charge for which the registered particulars do not include a negative pledge). BIS are looking for responses as to whether this would be possible and if any safeguards would be required, particularly in respect of unsecured creditors.
Type of charges
The type of charge to be registered is also being scrutinised – at present the list of types of charges registrable for companies incorporated in England & Wales and in Scotland differs. The consultation suggests that:
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the same rules should apply across the UK, and
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any charge should be registrable unless specifically excluded, with the only exclusion being Lloyd's trust deeds (save for Lloyd's deposit deeds and Lloyd's security and trust deeds) used in the insurance sector.
Registration procedure
In terms of the registration process itself, it is proposed that the particulars of the charge required to be registered (potentially by way of tick-box questions) should be restricted so there is neither a requirement for a description of the amount secured nor a description of the instrument creating the charge to be provided, which are both current requirements.
It is also suggested that the requirement for the original charging instrument (or a certified copy) to be delivered with the registration form should be abolished, with only the chargor able to register the charge.
If the charge is not registered within 21 days of its creation, the monies secured by it should be repayable on demand. Alternatively, it is suggested that there be a requirement to file the original charging instrument (or a certified copy) but Companies House should just check that the name of the chargor is the same as that in the filed particulars. Civil liability for the accuracy of the filed particulars should lie with the chargee and the existing criminal sanctions for failure to register a charge should be repealed.
Specialist Registers
The Companies Act 2006 allows the Secretary of State to make provision for facilitating information-sharing between different registries, and order that security registered properly in one register (such as over land at the Land Registry) will not then also require a second registration at Companies House. BIS proposes that the existing regime should continue until electronic conveyancing is introduced.
In Scotland, as a standard security cannot create security over any other asset, and such security is created on its registration by the Keeper, it may be easier to treat registration at the Scottish land registry as meeting the registration requirements of the 2006 Act.
BIS also seeks views on the overlap between the Companies House registration requirements and the Scottish register of floating charges should that come into existence (which will happen if the relevant provisions of the Bankruptcy and Diligence etc (Scotland) Act 2007 are brought into force).
The consultation closes on 18 June 2010.
Funding innovation for renewable energy
The UK Government’s Innovation Investment Fund (UKIIF), which was launched as part of the Government’s strategy to drive economic growth and create highly skilled jobs, has recently announced an investment fund called the Hermes Environmental Innovation Fund, which is intended to specifically benefit the renewables sector.
The Fund comprises £125 million in capital, managed by Hermes Private Equity, designed to invest in low carbon and clean technology venture capital funds and will also co-invest in companies in these sectors. It is important to note that co-investment will be in more mature companies, typically those that are revenue generating, and the investee companies will require to attract funding from other parties, with the amount raised often matched by the Fund.
The Fund invests in businesses which look to increase the efficient use of resources (both renewable and non-renewable) at all stages of production and consumption. UKIIF has stated it will invest in businesses at pre-profit and pre-revenue stages so the Fund is available to all businesses including start-ups and spin-outs. The Fund is looking to invest between £2 million to £10 million in a range of companies, from early stage to late stage companies.
The Fund is one of the latest to be launched with a focus on environmental matters, evidencing the importance that is being placed on this sector not just in the UK but throughout Europe. For example, the European Investment Bank was awarded the title ‘2009 Renewable Lender of the Year’ and has made lending for renewable energy, energy efficiency and low-carbon a priority, with a flexible approach that involves lending to the public and private sectors and for projects inside and outside the EU.
Closer to home, The Carbon Trust recently launched its £22.5 million Marine Renewables Proving Fund, which aims to accelerate the leading and most promising marine devices towards the point where they can qualify for the UK Governments existing Marine Renewables Deployment Fund and then widespread commercialisation. This fund will advance to successful applicants up to 60% of the project costs (with a maximum investment of £6m) for building and deploying wave and tidal stream prototypes.
The environmental sector is seen as one which can play a key role in leading the UK out of recession and it is hoped that the Fund will help the UK to build upon its existing expertise and innovation as a leader in the low carbon industry at a time when the availability of funding is being squeezed.
Recent research by The Carbon Trust shows that the UK is now the second largest low carbon and environmental economy in the world, with 3.5% of the global share. It is estimated that this should result in economic benefits and investment in the UK economy of £6-8 billion each year.
The matters covered in this ebulletin are intended as a general overview and discussion of the subjects dealt with. They are not intended, and should not be used, as a substitute for taking legal advice in any specific situation. Semple Fraser LLP will accept no responsibility for any actions taken or not taken on the basis of this publication.
For further information please contact: Douglas GOURLAY