Tag: United Kingdom

United Kingdom: A Reminder About Careful Drafting of Confidentiality Clauses for Shareholders

Katten Muchin Law Firm

The recent decision by the High Court of England and Wales (Chancery Division) in Richmond Pharmacology Limited (Company) v. Chester Overseas Limited, et al. underscores the need to carefully draft confidentiality clauses and to incorporate specific exceptions where these exceptions are reasonably foreseeable in the future. The case involved a shareholders agreement which contained a standard confidentiality clause requiring the parties to treat as strictly confidential all commercially sensitive information concerning the company subject to certain prescribed exceptions. One of the exceptions allowed disclosure to a professional advisor provided that the advisor agrees to be bound by a similar confidentiality obligation. Unsurprisingly, however, there was no specific exception allowing disclosures to a potential third-party buyer. Under the terms of the clause as drafted, the shareholder was required to obtain consent to make the disclosures. 

Over time Chester Overseas Limited decided to sell its shares and engaged a corporate finance advisor (Advisor) to assist in facilitating the sale. After the initial discussions regarding a management buy-out fell through, the Advisor sought to generate interest from third parties. In doing so, the Advisor took care to obtain nondisclosure agreements from certain of these potential buyers prior to disclosing the sensitive information. 

In its decision, the High Court stated that while the shareholder was entitled to disclose the information to its Advisor pursuant to the professional advisor exception, it was not authorized to disclose the confidential information to third parties.   

While the High Court’s decision regarding the confidentiality clause may not come as a surprise, it does reinforce the need to carefully consider a client’s position in future transactions governed under English law.   

The High Court’s decision is available here.

ARTICLE BY

Neil Robson
 
OF 
Katten Muchin Rosenman LLP

“Dual” Employment Contracts for US Executives Working in the UK

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Background

February 2014

Individuals, whether of British or foreign nationality, who reside in the UK are, in principle, taxable on their worldwide employment income. Many US executives who are “seconded” by their US employer to work in the UK may therefore become UK tax resident.

Such US executives who have not been UK resident in the three previous tax years and are not UK domiciled need not pay UK tax on their overseas earnings if they do not bring the income to the UK. Other US executives resident in the UK over the longer term may incur liability for UK tax on their overseas income unless their employer structures their employment duties under separate employment contracts, one with the UK subsidiary for their UK duties and another with the US parent for their overseas duties. These have become known as “dual contracts”. If the non-UK domiciled executive keeps the income earned under the overseas contract outside the UK, no UK income tax should arise on that income. He or she will pay UK income tax on the income earned in the UK under his or her UK contract.

“All Change”

In December 2013 HM Government announced that it would be clamping down on the artificial use of dual contracts for longer-term UK residents and has now published draft legislation that makes offshore employment income in a dual-contract arrangement taxable in the UK in certain cases.

The New Rules

Under the new anti-avoidance rules, which come into force on 6 April 2014, the dual-contract overseas income of US executives resident in the UK will be taxed in the UK if:

  • the executive has a UK employment and one or more foreign employments,
  • the UK employer and the offshore employer either are the same entity or are in the same group,
  • the UK employment and the offshore employment are “related”, and
  • the foreign tax rate that applies to the remuneration from the offshore employment is less than 75 percent of the applicable rate of UK tax. The current top rate of UK income tax is 45 percent, and 75 percent of this rate is 33.75 percent.

The UK employment and the offshore employment will be “related” where, by way of non-exhaustive example:

  • one employment operates by reference to the other employment,
  • the duties performed in both employments are essentially the same (regardless of where those duties are performed),
  • the performance of duties under one contract is dependent on the performance of duties under the other,
  • the executive is a director of either employer, or is otherwise a senior employee or one of the highest earning employees of either employer, or
  • the duties under the dual contracts involve, wholly or partly, the provision of goods or services to the same customers or clients.

Action

US corporations should urgently review the use of dual contracts for their non-UK domiciled executives seconded to their UK subsidiaries before the 6 April 2014 start date. The proposed legislation is widely drafted and has the potential to catch even genuine dual-contract arrangements. If one of the dual contracts is with a group employer in a low-tax jurisdiction, that contract may be especially vulnerable. Dual contracts will not necessarily become extinct, but in the future, careful cross-border tax advice should be sought in their structuring.

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Of:

Vedder Price

UK Financial Conduct Authority (FCA) Issues First Fine Under New Anti-Money Laundering Regime

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Financial Conduct Authority fines Standard Bank £7.6 million for failures in its anti-money laundering controls, underlining the importance of both having and implementing adequate policies in relation to money laundering.

On 22 January, the UK Financial Conduct Authority (FCA) published a decision notice[1] imposing a £7.6 million fine on Standard Bank PLC, the UK subsidiary of South Africa’s Standard Bank Group.[2] The fine was issued for failures relating to Standard Bank’s anti-money laundering (AML) policies and procedures for corporate customers connected to politically exposed persons (PEPs).[3] This is the first AML fine issued under the FCA’s new penalty regime and the first such fine by the FCA—or its predecessor, the Financial Services Authority—in relation to commercial banking activity.

Under Regulation 20(1) of the Money Laundering Regulations 2007, regulated institutions, such as banks, must establish and maintain “appropriate risk-sensitive policies and procedures” on customer due diligence measures and ongoing monitoring of business relationships, amongst others. The policies must be aimed at preventing money laundering and terrorist financing. Guidance issued by the Joint Money Laundering Steering Group states that enhanced due diligence (EDD) should be applied where a corporate customer is linked to a PEP, such as through a directorship or shareholding, as it is likely that this will put the customer at higher risk of being involved in bribery and corruption.

As part of its investigation into Standard Bank, the FCA reviewed a sample of 48 corporate customer files, which all had a connection with a PEP, and discovered “serious weaknesses” in the application of the bank’s AML policies and procedures. The FCA found that, from 15 December 2007 to 20 July 2011, Standard Bank breached the Money Laundering Regulations 2007 by failing to take reasonable care to ensure that all aspects of its AML policies were applied appropriately and consistently to its corporate customers connected to PEPs. In particular, the FCA found that Standard Bank did not consistently carry out adequate EDD measures before establishing business relationships with corporate customers linked to PEPs and did not conduct the appropriate level of ongoing monitoring for existing business relationships by updating its due diligence. The FCA noted the failings were particularly serious because the bank dealt with corporate customers from jurisdictions regarded as posing a higher risk of money laundering and because the FCA had previously stressed the importance of AML compliance to the industry.[4] The gravity of the failings was underlined by the FCA’s director of enforcement and financial crime, who stated that “[if banks] accept business from high risk customers they must have effective systems, controls and practices in place to manage that risk. Standard Bank clearly failed in this respect”.

This is the first AML case to use the FCA’s new penalty regime, which applies to breaches committed from 6 March 2010 and under which larger fines are expected. The FCA’s decision notice sets out how it determined the level of the fine, by reference to a five-step framework (as outlined in the Decision Procedure and Penalties Manual).[5] The FCA considered the fact that the bank and its senior management cooperated in the investigation and took significant steps to remediate the problems, including seeking advice from external consultants, to be a mitigating factor. In addition, Standard Bank’s decision to settle the matter at an early stage of the investigation resulted in a 30% discount on the fine. The original penalty was £10.9 million.

The FCA’s action against Standard Bank illustrates the increasingly tough approach taken by the UK authorities against financial crime and shows that the FCA is willing and able to enforce AML legislation. Banks and regulated firms are encouraged to ensure that they have effective policies and procedures against money laundering in place and that these are being adhered to.

[1]. View the FCA’s notice here.

[2]. The sale of Standard Bank to the Industrial and Commercial Bank of China has been agreed to and is likely to be completed during the fourth quarter of 2014.

[3]. A “PEP” is defined in the Money Laundering Regulations 2007 as “an individual who is, or has, at any time in the preceding year, been entrusted with a prominent public function”, or immediate family members and known close associates of such individuals.

[4]. The FSA published a Consultation Paper on 22 June 2011, availablehere, focusing on how banks manage money laundering risk in higher risk situations. It also published a Policy Statement on 9 December 2011, available here, providing guidance on the steps firms can take to reduce their financial crime risk.

[5]. View the manual here.

Article by:

Of:

Morgan, Lewis & Bockius LLP

Caveat Emptor: Due Diligence of the United Kingdom Continental Shelf Oil and Gas Assets

Andrews Kurth

 

This article explores the due diligence of United Kingdom continental shelf (“UKCS”) oil and gas assets from a buyer’s perspective. Good management, organisation, communication, clarity and common sense are the key to a successful due diligence exercise. The scope of the due diligence review will depend on a number of factors, including whether the buyer has any knowledge of or a current participating interest in the target asset, whether the asset is in the exploration or production phase or is an operated asset, the size of the deal and any cost and time restraints. Whether a buyer requires a red flag due diligence report or a comprehensive report on the asset, care must be taken to ensure that no stone is left unturned during the course of the review. Failure to do so may result in undesirable consequences.

Preparation

Before embarking on an extensive review of the documentation provided by the seller, the buyer should seek to determine the scope of the due diligence exercise at the outset to prevent it from becoming a moving target which may lead to inefficiencies and unexpected cost implications. Sometimes the prospective buyer will investigate the asset with a view to purchase. More often than not, due diligence of the asset will amount to no more than a tyre-kicking exercise. The intention of the prospective buyer will therefore ultimately colour the scope of the due diligence undertaken.

As well as considering the information memorandum prepared by the seller (if any), it is also useful for the buyer to geographically place the asset by consulting a map of theUKCS licence interests and blocks. Such preparations will enable the buyer to better piece together the documentation provided in respect of the target asset and request any missing information from the seller.

Data Room

Whether the seller furnishes the buyer with a virtual or a physical data room, the buyer must keep an accurate record of the documents that have been disclosed. If a virtual data room is employed, the buyer must ensure that it is notified when new documents have been provided and, if documents are supplied in soft or hard copy outside of the virtual data room arrangement, details should be kept of these by the buyer as well. This is all essential because all disclosure will later form part of the sale and purchase arrangements between the buyer and seller.

Data rooms for asset disposals typically include legal, financial, technical, commercial and operational documents. One of the first tasks that a buyer should undertake is to review the data room index, if one has been provided, and allocate documents to the various specialists for review; careful coordination is paramount to ensure that all bases are covered. If no index has been supplied, one should be requested from the seller and, if such index is not forthcoming, it is recommended that the buyer compiles an index so that it can keep a running record.

Depending on the scale of the exercise and number of people employed to assist, the coordinator of the due diligence exercise should ensure that team members effectively communicate with each other. Typically, virtual data rooms limit access rights to a small pool of permitted entrants, so responsibilities should be allocated between professionals at an early stage. Data rooms are often poorly organised so it is important that the coordinator is made aware of documents which have been filed out of place in order for them to be allocated to the correct team members for review. This way, no document will be overlooked.

Title Verification

A UKCS asset is typically represented by a licence, a joint study and bidding agreement (“JSBA”) or joint operating agreement (“JOA”) and, in some cases, a working interest assignment. Assets may also be subject to a unitisation and unit operating agreement (“UUOA”), transportation, processing and petroleum sales agreements and other material project contracts.

One of the key objectives of the buyer’s due diligence is to determine whether the seller actually holds an interest in the asset. Often an asset will be described inconsistently in the documentation by which it is governed and may not correspond accurately with the information held by the Department of Energy and Climate Change (“DECC”). This is especially true of those assets historically operated under a JOA which has been subsequently sub-divided to apply to multiple blocks within a licence, or those assets with an alias which has stuck over the passage of time. It is therefore very important that both parties are agreed on the correct identity of the asset being bought and sold from the outset.

Similarly, infrastructure assets are frequently referred to under a variety of guises and are often complex in nature. For instance, the Sullom Voe Terminal, which is one of the largest oil terminals in Europe, handles production from more than twelve oil fields in the east Shetland Basin and approximately twenty different companies presently hold interests in the terminal. This, combined with the fact that it has been 35 years since first oil arrived at the Sullom Voe Terminal, means that tracing title to this infrastructure asset is likely to be a knotty and time-consuming exercise.

Although DECC holds data on all offshore licences, this should by no means act as a substitute for mechanically tracing title to an asset, however tempting this may be. Many UKCS assets date back over 40 years and so tracing title back to their inception can be a lengthy process. The buyer must therefore decide whether it wants to undertake or commission such work, or whether it can take comfort from tracing title back through only a limited number of transfers and seek a full title guarantee from the seller. Extensive title representations and warranties may reduce the scope of title due diligence but often they will be qualified by the information, or lack thereof, disclosed to the buyer in the data room and so are not a reliable remedy if there is a title defect.

There may be some merit in tracing title of each material contract back to the date on which it became effective in order to determine whether or not it is relevant to the transaction. Sometimes contracts in the data room will have been entered into by parties which are neither the seller nor its predecessors in title and, in other cases, may not be relevant to the target asset at all. In these circumstances, and depending on the purchaser’s view of the asset, it may be more efficient to determine which contracts are required to be assigned or novated at the due diligence stage rather than when the parties are seeking to complete the deal.

An additional complication is that a company which was originally the holder of an interest in an asset may have changed its name since it was first registered at Companies House. The buyer should therefore consult the change of name register held by Companies House at the start of the due diligence exercise and take note of any previous names. This will enable the buyer to piece together information relating to the asset more easily.

Title to assets, excluding infrastructure, is evidenced by the relevant licence, JSBA or JOA and, if applicable, UUOA. Typically, a transfer of a participating interest will be evidenced by a JSBA or JOA deed of novation, and if applicable a UUOA deed of novation, which will provide for the transfer of the relevant participating interest from the seller to the buyer. Conversely, not every transfer of a participating interest will be evidenced by a licence assignment. An example of this is where the buyer and seller are already party to the JOA and/or UUOA. If neither the buyer nor the seller is joining or leaving the licence, and the parties are simply adjusting their participating interests under the JOA and/or UUOA, a licence assignment will not be required. In the same way, where a licence governs multiple blocks and the buyer has an interest in another block covered by the licence and the seller is also remaining on the licence, either because it has an interest in another block covered by the licence or because it is only selling part of its interest to the buyer in the relevant block, when the buyer acquires the interest in the relevant block, a licence assignment will not be required.

There is often a question asked as to whether working interest assignments are required to show a complete chain of title to an asset. A working interest assignment evidences the transfer of the beneficial interest in the asset. The more prevalent view is that this type of assignment is no longer necessary to perfect title, especially where there is a JSBA, JOA or UUOA already in place. Its purpose, being a document on which stamp duty was levied, is now obsolete. Although, buyers and sellers still frequently include the working interest assignment in their suite of completion documents by means of convention, it is not obligatory to enter into this assignment to complete an asset transfer. Due to the disproportionate amount of time and energy that buyers and sellers may spend in hunting for non-existent working interest assignments to evidence a complete chain of title, the better view may be to exclude the working interest assignment from the scope of the title due diligence exercise.

Assignment

Pre-emption rights and consent provisions are principal deal-structure considerations and should therefore be given top priority when conducting the due diligence exercise. Their consequences may prevent the proposed deal from going ahead, increase the cost of the transaction if co-venturers are permitted to withhold their consent on the grounds of financial incapability unless some form of financial security is provided by the buyer and/or cause the deal to be restructured as a share sale. It will therefore be important to review the assignment provisions of all the material contracts, and particularly any JSBAs, JOAs and UUOAs, to identify such obstacles at the earliest possible stage.

If an asset is governed by both a JOA and UUOA, care needs to be taken in order to determine whether the pre-emption and/or consent provisions in one or both agreements apply. Often the UUOA will expressly state that the provisions in the UUOA supersede the provisions in the JOA to the extent that they conflict. In this case, the assignment provisions in the UUOA will override the assignment provisions in the JOA in respect of the area covered by the JOA which forms part of the unit area. Any remaining area that is solely governed by the JOA will be subject to the JOA pre-emption and consent provisions. If it is not clear from the documentation whether the provisions in the UUOA or JOA will prevail, the better approach for a buyer to take may be to err on the side of caution; in other words, to apply the more onerous pre-emption and/or consent provisions to the whole of the asset transfer or consider restructuring the transaction as a share sale.

Material Contracts

The scope of the due diligence review of material contracts is likely to be determined by the materiality threshold proposed by the buyer with respect to contract value. The buyer should review all material contracts in order to ascertain whether the seller has the necessary rights under such contracts and identify potential liabilities, risks and onerous provisions that affect the valuation of the asset or, worse still, could prevent the deal.

It is important that the correct selling entity holds an interest in the relevant material contract and any inconsistencies should be highlighted to the buyer so that the seller can arrange for any necessary inter-group transfers in good time if required. The buyer should also be vigilant to any poison pills that kill the contracts in the event of a change of party or change of control.

If time, cost and scope permit, it can be invaluable to prepare full and accurate contract summaries of all material contracts. The simplest and most efficient way of doing this is to table contract summary templates for the various categories of contract. For instance, there could be separate templates for licences; JSBAs, JOAs and UUOAs; petroleum sales agreements; transportation and processing arrangements; and sundry agreements, if applicable. Templates are useful aides to those reviewing the asset documentation. Firstly, they ensure that all members of the team focus and report on every provision of the contract within the scope of the due diligence exercise. Secondly, and especially for large scale due diligence reviews, they are important for the purposes of consistency and efficiency. The buyer’s due diligence report should be informative, concise, on point and appear to have been written by one person. Full, tailored contract summaries help to achieve this purpose.

Contract summaries also serve a bigger purpose. If after the due diligence exercise the buyer decides to enter into a sale and purchase agreement with the seller and proceed to completion, the closing documents will include deeds of assignment and novation for the various material contracts. Complete contract summaries make the task of deducing which material contracts will need to be assigned or novated easier. They also make for a more efficient process as they prevent the buyer from having to re-locate each document in the data room and re-review their provisions.

If the asset is producing or has an approved field development plan, the buyer should expect to see material contracts in the data room relating to petroleum sales agreements and lifting, transportation and processing arrangements. Particularly in respect of some of the older UKCS assets, it is not always clear whether a document is historical or not. Typically, the buyer will exclude historical construction, tie-in commissioning and joint development agreements from its due diligence scope and place less emphasis on reviewing pipeline crossing and proximity agreements, unless it has a particular interest in the provisions of such documents.

It is likely that the data room will include some material contracts which are governed by the laws of another country or state. Depending on the importance of such contracts, the buyer should consider whether to seek advice from local counsel. In addition, in the course of due diligence for an asset acquisition, it is likely that there will be property and tax related documentation and these should be reviewed by specialists in those fields. It may also be necessary to examine the proposed transaction from a competition perspective and so the need for competition lawyers should be considered at an early stage.

During the due diligence exercise, the buyer should be aware of any information which evidences that the seller has been acting in breach of contract or is in breach of its licence obligations. Any current or anticipated claims from third parties or on-going litigation will be of particular interest to the buyer and should be noted. The buyer should also be alerted to whether any contractual provisions will be breached by the acquisition of the target asset if they are ignored by the buyer. For instance, often under seismic data contracts data must be returned or a supplemental fee paid if the identity of the purchasing company alters.

On completion of a transaction, the buyer will want all material contracts to be novated to it from the seller, unless the transaction is structured as a share sale. In some circumstances this may not be possible if third-party consents remain outstanding and so the seller and buyer should use their reasonable endeavours to obtain such consents post completion. Typically, this approach is only taken in respect of those contracts of limited value or importance. The seller will agree to hold such contracts as trustee and agent of the buyer and the buyer will agree to perform such contracts on the seller’s behalf and indemnify the seller against any costs or liabilities it incurs in respect of such arrangement. This split completion approach is not always possible in respect of those agreements which are contractually linked to others or to the transfer of the participating interest. The buyer should therefore bear in mind any linkage provisions that it uncovers in its due diligence exercise.

Decommissioning

The buyer will be keen to discover whether a field-wide decommissioning security agreement is in place for the target asset or whether the JSBA, JOA and/or UUOA include decommissioning security provisions. Where decommissioning security provisions exist, the buyer should consider the type and amount of security required, the credit rating of such security, whether the asset is in the run-down period and/or how the trigger date is calculated. Depending on the terms of the transaction and whether a section 29 notice has been served on the seller before the asset is transferred to the buyer, the buyer may need to provide security for decommissioning under the sale and purchase agreement to the seller as well. Decommissioning arrangements will be a fundamental consideration to the buyer’s valuation of the asset and will therefore always require financial and/or actuarial input.

Encumbrances

The buyer should conduct a charges search at Companies House in order to determine whether the seller should arrange for any outstanding encumbrances over the asset to be released as part of the transaction. The buyer should also be concerned with any third-party royalties over the seller’s interest in the asset. Any royalty payments on production in respect of all petroleum won and saved will have an impact on the financial value of the target asset and so the buyer should factor the existence of these into its valuation.

Likewise, details of any outstanding cash calls, sole risk activity or carried interests may also be important considerations for the buyer and their existence may result in an adjustment of the price the buyer is prepared to pay for the asset.

Questions and Answers

The question and answer process is central to the due diligence exercise and is an important string to the buyer’s bow. By asking the seller questions, the buyer can better understand the seller’s asset from the responses provided and seek to address any holes or limitations in the data room documents. A classic example of the curious incident of the dog that didn’t bark in the night is the unknown existence of an area of mutual interest agreement which, in the most draconian of circumstances, may prevent a buyer from completing its transaction with the seller, or may prevent the buyer from applying for and/or acquiring an interest in another particular licence area post completion of its transaction with the seller.

If draft contracts have been included in the data room the buyer should ask the seller to confirm whether final versions have been executed and, where documents which have been provided during the due diligence exercise refer to others which have not, the buyer should request these missing documents from the seller. The buyer should maintain an accurate list of questions that have been submitted to the seller and the responses received. Sometimes questions will be answered unsatisfactorily and it is therefore important for the buyer to re-phrase or pursue answers to the originals.

The buyer may also choose to contact DECC with questions on an unnamed basis during the due diligence exercise if there appears to be an inconsistency between the asset data held by DECC and the documentation provided by the seller in the data room. In doing so, the buyer must be careful not to breach any provisions contained in any confidentiality or non-disclosure agreement that has been entered into between the buyer and seller in respect of the transaction.

Conclusion

The buyer conducts due diligence so that it can properly evaluate the risks and benefits to it in acquiring a particular asset, re-negotiate the price that it is prepared to pay for the asset, and decide whether or not to go ahead with the purchase. The due diligence report should identify and quantify issues found and propose solutions for the buyer to consider. Depending on the concerns identified, traditional contractual protections in the sale and purchase agreement may be insufficient and, consequently, the buyer may decide to walk away from the deal. The importance of the due diligence exercise is therefore paramount.

Article by:

Rebecca Downes

Of:

Andrews Kurth LLP