Corporate & Commercial Autumn Update

Case Law Updates

In this Update, there are some interesting clarifications on the extent of duties owed by a director to his company and in particular the consequences of failing to disclose and/or avoid conflicts of interest. Our first 2 cases highlight the need for directors to have in place correct procedures for notifying their companies of any potential conflict.

In addition, recent decisions in the commercial arena help add clarity to the extent of terms which can be implied into certain agreements and the need for well drafted exclusion clauses, along with highlighting the confusion when parties overlook the actual signing of a contract and choose instead to rely on an exchange of emails.

Preventative measures taken on Director dealing in a Competitive Business

In the case of G Attwood Holdings Ltd and Woodward [2009], the court clarified the extent that directors may go to in preparing for future competition against their companies and whether the company is able to restrain them from such competition where employment contracts contain no restrictive covenant.

In the case in question, prior to resigning, a director proposed to set up a competing business with the company comprising himself and a senior employee. He had approached his company’s existing clients regarding his new enterprise, taken copies of company documentation and retained confidential information. The judge decided that the director was in breach of his fiduciary duty and in breach of contract in setting up a competitive business even though there were no restrictive covenants in his director’s contract. The company proved that the director had failed to disclose to it the threat of competition, that before resigning as a director he had breached his duty to avoid a conflict and after resigning he had exploited the opportunity arising from his position as a director of the company.

The court took the view that preparations for the new business such as putting together a business plan and seeking funding did not automatically breach a director’s duty to his company. However, approaches to customers of the company on behalf of the director’s new venture were a clear breach of duty.

As well as awarding damages the court allowed an injunction that was in place to continue until one year after the director’s resignation to provide the company with sufficient protection against the competition of the director’s new company.

Directors should be aware that simply because they are leaving a company, their duty to the current company does not cease. If in any doubt, a director should make full disclosure of any matter which may give rise to competition, a conflict of interest or the making of separate profit. This decision is particularly relevant if there are no restrictive covenants in place as it provides an alternative means to for a company to prevent the competition by bringing an action for a breach of directors’ fiduciary duties in situations where a director has acted to facilitate his new company prior to resignation from the old. The Articles of Association of a company should contain an appropriate procedure in which any such conflict is declared and, where relevant, approved either at board or shareholder level.

Director liable when a payment earmarked for one debt was used to pay another

Under the codified description of directors’ duties in the Companies Act 2006, a director is under a duty to avoid situations where he has (or potentially has) an interest which conflicts with that of the company. Directors should declare any such interest to the company and can be held accountable if they do not do so.

The Courts have recently found a director guilty of a serious conflict of interest concerning a payment by the company. The court emphasized that where the payment results in the insolvency of the company in particular, the director could be personally liable.

In the case of Palmier PLC (In Liquidation), a clothing company had severe cash flow issues and had difficulty paying debtors. However, the company was due a VAT rebate and this amount was to be set aside to discharge trade debts and to fund ongoing trading. The director in question instead used the earmarked funds to pay outstanding commission to a company of which he was also the director. The clothing company became subsequently became insolvent.

It was argued that the director had not made the company aware of the extent of his interest in his second company (non disclosure of his interest) and that he had been inflating the amount of commission payable to that company (dishonesty).

The court ruled that the director had been guilty of a conflict of interest and had acted dishonestly. The judgment makes clear that the director’s interest in his second company placed him in a conflicting position and he had been in breach of his fiduciary duty in not declaring the interest. In inflating the commission payable the director had been dishonest. The director was ordered to repay the amount of overstated commission and to restore the amounts earmarked from the VAT rebate.

As with the above decision, directors should be aware of the need for transparency in all of their dealings and that correct procedures for approval should be adhered to if there is any potential direct or indiret conflict. Companies are advised to ensure that the procedure within their Articles of Association accurately reflect the disclosure/transparency steps envisaged by Companies Act 2006 which was fully implemented on 1 October 2009.

Goods to be of Satisfactory Quality for a reasonable time after Delivery

The High Court has confirmed that a term should be implied into “free on board” contracts that goods should be of satisfactory quality and in accordance with any contractual specification not only when delivered to the vessel for transportation but also for a reasonable period after.

“Free on board” terms are used in international contracts and require a seller to deliver goods onto a ship for onward shipment to the buyer.

In the recent High Court case of KG Bominflot v Petroplus Marketing [2009], oil was delivered under a free on board contract to a ship sailing to Antwerp. Although the oil met the specifications in the contract at the time it was delivered as cargo, it deteriorated throughout the voyage and did not meet the specifications when it arrived at its destination. The free on board contract contained an exclusion clause which provided that the seller did not guarantee, warrant or make any representations as to the suitability/fitness of the oil.

The High Court held that the Sale of Goods Act allows a term to be implied into free on board contracts that the goods will be of satisfactory quality not only when the cargo is delivered onto the ship but for a reasonable time afterwards. Additionally, the goods should remain in accordance with any contractual specification for a reasonable period of time. The length of time of such reasonable period is a matter of fact for the court to determine but will depend on factors such as whether the seller knows if the buyer will be selling the goods on or using them itself. Although an exclusion clause was included in the contract in this instance, the exclusion did not expressly exclude conditions implied under the Sale of Goods Act.

This case highlights that companies involved in international sales of perishable goods should consider the suitability of the goods to travel – it is not simply enough to leave the goods on the vessel to have completed the seller’s side of the bargain. Additionally, such companies may wish to consider their contractual procedures and the making of enquiries as to the use the buyer intends for the goods. The case also draws attention to the need for well drafted exclusion clauses. The implied condition that goods must be of satisfactory quality can be restricted or excluded if it is reasonable to do so but clear wording is needed.

What is a Reasonable Time for Termination of a Contract?

The High Court has confirmed that it will determine what constitutes reasonable notice for termination of a contract, where an express term is not included, by looking at the facts at the time the notice was given not at the time the contract was entered into.

In the recent case of Jackson Distribution Limited v Tum Yeto Inc [2009], a clothing manufacturer confirmed in discussions that the distributor would be the sole distributor of the products. The parties exchanged emails regarding the payment terms and began trading. Each party subsequently sent its own draft distribution agreement to the other party but neither draft was ever signed. Two years into the arrangement the manufacturer gave the distributor 6 months notice to terminate their arrangement. The distributor sued for breach of the contract, alleging that the notice was insufficient.

The High Court concluded that the arrangement was governed by the agreement made by the parties’ emails as no distribution agreement was signed. The court considered the facts including the lack of formal arrangement between the parties, the length of relationship of the parties and the absence of any clause preventing the distributor from selling products in competition with the manufacturer. On those facts, it was decided that there was an implied term that reasonable notice for termination would be 9 months.

This case sets out the factors that a court will look at in determining a reasonable notice period but also serves to highlight the benefits of ensuring that the formal agreements are not overlooked once arrangements commence. Both parties could then have had the clarity of knowing the exact notice due under the agreement from the outset of arrangements if the agreement had been completed.

Higher Contractual Rates of Interest may be Permitted

The Late Payment of Commercial Debts (Interest) Act 1998 provides for a statutory interest rate on late payments of debts arising under business contracts. This amount is currently 8% above the base rate of the Bank of England. Parties can agree a different contractual interest and we are used to seeing something like 3% above a high street bank's base lending rate.

A contractual interest rate that is unreasonably high is likely to be struck down by a Court on the grounds that it is in fact intended to be a penalty and accordingly void for public policy reasons.

In the case of Taiwan Scot v Masters Golf Company [2009], the Court of Appeal held that a contractual rate of 15% was not a penalty rate. In this case, a purchaser bought golf clothing made in China from a Seller to resell in the UK and paid for part of these. Following complaints from customers, the purchaser refused to satisfy outstanding invoices that the Seller had delivered. The Seller brought a claim for the unpaid debt plus interest at the contractual rate of 15%. The court found in favour of the Seller and held that the rate of 15% interest had been agreed through negotiations by two “commercial parties” against the background of an economic period where such a rate of interest was not inappropriate.

This decision suggests that parties may be able to agree higher rates of interest than initially considered without the rate being set aside as a penalty. However, as a word of caution in setting rates in this climate, the interest achievable needs to be considered alongside the background of the interest rates at the time of negotiation and entering into of the contract. What was relevant in this case was that the parties were both commercial parties and had equal bargaining power at a time when interest rates were much higher than the present.

Company Law Update

Listed Company Accounts to show Directors’ Salary

For financial years beginning on or after 6 April 2009 listed companies are required to provide further information in their directors’ remuneration report under the Large and Medium Sized Companies and Groups (Accounts and Reports) Regulations 2008. In the report directors will have to set out how they have taken employee pay and employment conditions into account when determining directors’ pay for the relevant financial year. This obligation will not apply to companies whose year end finishes on 31 December or 31 March unless the Company decides to comply with this obligation voluntarily. However, the obligation will apply for those companies next financial year.

Commercial Law Update

Online providers of Goods and Services to check age of their Customers

The Online Purchasing of Goods and Services (Age Verification) Bill has been circulated by parliament for consultation. The purpose of the Bill is for online providers of goods and services to take reasonable steps to establish the age of their customers making remote purchases. The proposed Bill aims to address concerns with the lack of checks required to be carried out by online sellers a loophole exists allowing goods or services inappropriate for certain ages to be purchased via the internet. The Gambling Act 2006, which came into force last September, specifically requires online gambling companies to implement an age verification service and as such this is not an entirely new concept. We will keep you informed of any progress with the Bill.

Polluters to be Punished

The Environmental Damage (Prevent and Remediation) Regulations 2009 entered into force on 1 March 2009. They are based on the ‘polluter pays principle’ so those responsible prevent and remedy environmental damage, rather than clean up costs being borne by the Treasury.

‘Environmental damage’ has a specific meaning in the Regulations, covering only the most serious cases and existing environmental legislation will remain in force.

Under the Regulations environmental damage includes:

• serious damage to surface or ground water
• contamination of land where there is significant risk to human health;
• damage to Biodiversity and EU protected natural habitats.

The Regulations requires to operators to notify and take preventative measures and guidance has been issued by DEFRA as to when ‘environmental damage’ has occurred. Failure to comply is a criminal offence. Operators will need to exercise rapid judgement as to whether any particular incident or circumstances falls within the scope of the Regulations and ensure that appropriate assessment/reporting procedures are in place. It has also been suggested that the duty to notify may also increase the risk of disputes under environmental indemnities given in the context of acquisition, as these typically exclude liability for losses arising from voluntary notifications made to regulators.

Useful Business Links

Financial Reporting Council publishes draft Guidance for Directors of UK Companies

HMRC Video Diaries for New and Small Businesses

Changes to Government Trade Credit Insurance Top Up Scheme

Since 1 May 2009, companies that have had their credit insurance cover reduced have been able to purchase up to 6 months top-up cover. Following feedback from businesses, three changes will be made to these rules:

1. the price of the cover has been reduced from 2% to 1%;
2. there is now no lower limit on top up cover; and
3. the upper limit has been increased to £2 million.

Penalty for failure to file annual accounts

Under the Companies Act 2006 companies now have only 9 months rather than 10 in which to file their accounts.

A sliding scale of late filing penalties has been introduced. For private companies which file their accounts not more than 1 month late the minimum fine is £150 which rises to £1,500 if they are over 6 months. For public companies, the scale ranges between £750 - £7,500. The penalties will be doubled if a company files its accounts late in 2 successive financial years beginning on or after 6 April 2008.

Essential checklist for Small and Medium sized Businesses

Anti Money Laundering Registration

The Office of Fair Trading has released a list of businesses that will need to register with it by February 2010 with an aim to reducing the possibility of legitimate businesses being used for money laundering. The categories of businesses are:

• estate agents; and
• consumer credit financial institutions (consumer credit lending activity companies not authorised by the Financial Services Authority or supervised by HM Revenue and Customs).

Reduction in costs for Environmental Permits

Role and Responsibilities of Non-Executive Directors

Checklist for Small Businesses collecting Information about its Customers