Month: January 2024

In this case, Catherine McAndrew, a Senior Associate in the Insurance and Reinsurance team at CMS, comments on the Supreme Court’s decision in TUI Limited v Griffiths [2023] UKSC 48I, which was handed down on 29 November 2023.

The Supreme Court considered whether it was open to a court to reject evidence, in this case expert medical evidence, which was disputed but which had not been tested by cross-examination. The claimant’s expert report supported the causation of his injury, but the expert had not been required by the defendant to give oral evidence.  

The Supreme Court concluded that, despite certain deficiencies in the report, its dismissal by the trial judge in the absence of cross-examination had deprived the claimant of a fair trial. 

Background

The claimant entered into a package holiday contract with the defendant for a 14 night, all-inclusive holiday to Turkey between 2 August and 16 August 2014.

On 4 August 2014, the claimant began to suffer from gastric symptoms. After two days, his symptoms were less severe and he began to improve, however they did not stop completely. On 7 August 2014, he travelled to a local town and ate at a local restaurant but was unable to eat much due to lack of appetite. On 13 August 2014, he was admitted to hospital where he was diagnosed with acute gastroenteritis. A stool sample showed multiple pathogens, both parasitic and viral. Though still feeling unwell, the claimant travelled home on 16 August 2014.

The claimant had eaten a fast food meal at the airport prior to commencing his holiday but, other than the meal he ate on 7 August, all food and drink was consumed at the hotel.

The claimant issued proceedings against the defendant in August 2017 for damages as a consumer under the Package Travel, Package Holiday and Package Tour Regulations 1992 and under Ss 4 and 13 of the Supply of Goods and Services Act 1982. The claim was allocated to the multi-track.

The defendant denied that the claimant’s illness was due to food and/ or drink consumed in the hotel and put him to proof as to the cause of his illness. The claimant obtained reports from a gastroenterologist, Dr Thomas, and a microbiologist, Professor Pennington. The defendant was given permission to rely on expert evidence from a gastroenterologist and a microbiologist, however (i) it failed to adduce evidence from a gastroenterologist in time and failed in its application for relief from sanctions; and (ii) it chose not to serve a report by a consultant microbiologist. The defendant therefore proceeded to trial without adducing any expert evidence. Further, the defendant’s witnesses of fact were not called or cross-examined, and so their evidence was discounted. The defendant did not seek to have the claimant’s expert Professor Pennington attend trial for cross-examination.

Lower Courts

In 2019, the trial judge (Her Honour Judge Truman) accepted the evidence of the claimant and his wife but made no findings of fact on the hygiene standards at the hotel. The judge recorded the evidence of the gastroenterologist in relation to diagnosis and prognosis. The microbiology report prepared by Professor Pennington and his replies to the defendant’s Part 35 questions were the only expert evidence on causation before the judge at trial. The defendant’s counsel criticised Professor Pennington’s report in his skeleton argument, served the afternoon before trial, and in closing submissions. Those criticisms formed the basis of the judge’s decision.

Professor Pennington’s report briefly considered the various possible causes of the claimant’s illness and concluded that, on the balance of probabilities, he had acquired his gastric illness following consumption of contaminated food or fluid at the hotel.

In finding against the claimant, the judge was critical of Professor Pennington’s report and responses provided in light of the written questions put to Professor Pennington under Civil Procedure Rule (“CPR”) Part 35.6 (which deals with expert evidence), but principally his failure to explain why he had concluded the source of infection was the hotel rather than other potential sources.

The claimant successfully appealed to the High Court. The judge considered that the case raised a fundamental question concerning the proper approach of the court towards uncontroverted evidence. The judge considered that two questions had to be answered:

whether the court is obliged to accept an expert’s uncontroverted opinion even if that opinion was an ipse dixit (a bare statement of opinion without adequate justification) and,

if the court is not so obliged, under what circumstances the court could justify rejecting the evidence.

The judge concluded that the court could reject an uncontroverted expert report if it were literally ipse dixit. However, what the court was not entitled to do, when faced with an uncontroverted expert report, was:

“…subject the report to the same kind of analysis and critique as if it was evaluation a controverted or contested report, where it has to decide the weight of the report in order to decide whether it was to be preferred to other, controverting evidence such as an expert on the other side or competing factual evidence. Once a report is truly uncontroverted, that role of the court falls away. All the court needs to do is decide whether the report fulfils certain minimum standards which any expert report must satisfy if it is to be accepted at all.”

Those minimum standards can be found in the Practice Direction to CPR 35.6, para 3.

The judge concluded that, although there were deficiencies with Professor Pennington’s report, it was not a bare ipse dixit and was sufficiently compliant with the minimum standards identified. The appeal was therefore allowed.

Court of Appeal

The defendant appealed to the Court of Appeal. Aplin LJ and Nugee LJ allowed the appeal, with Bean LJ dissenting.

Asplin LJ, delivering the leading judgment, found that the High Court was wrong to hold that, faced with an uncontroverted expert report, the court was not entitled to evaluate that report but instead simply consider if it met the minimum standards set out in the Practice Direction. Asplin LJ considered that the report failed to provide a range of opinion and lacked adequate reasoning in support of the expert’s conclusion. Nugee LJ agreed with Asplin LJ and held that trial judges had to evaluate all of the evidence, including evidence that is uncontroverted, and decide the weight to afford that evidence.

Bean LJ strongly dissented, describing as trite law that, in general, a party is required to challenge on cross-examination the evidence of any witness of the opposing party it wishes to submit to the court that that evidence should not be accepted. Bean LJ considered that the defendant should have cross-examined Professor Pennington if it wished to challenge his evidence and that a court should accept the evidence of an expert which is not subject to cross-examination (uncontroverted). Ben LJ considered that leaving challenges until closing submissions was litigation by ambush and that the claimant had not been afforded a fair trial in the circumstances.

The claimant appealed to the Supreme Court.

Decision of the Supreme Court

The claimant was successful on appeal to the Supreme Court.

The court considered that making closing submissions attacking an expert’s evidence was neither fair nor sufficient. Professor Pennington’s report may have been “terse” and lacking in certain respects, but it did provide reasonable justification for the expert’s conclusion on causation. It was not a mere expression of opinion. His evidence ought to have been tested by cross-examination.

With reference to a statement in Phipson on Evidence, that a party is required to challenge on cross-examination the evidence of any witness of the opposing party if it wishes to submit to the court that that evidence should not be accepted, the court found that the claimant had been denied a fair trial. Maintaining the fairness of the trial included ensuring fairness to the witness whose evidence was being impugned and enabling the judge to make a proper assessment of all the evidence. Cross-examination gave the witness the opportunity to explain or clarify his or her evidence. That principle was not limited to cases in which the witnesses’ honesty was being impugned, but rather was of general application. 

It is important, however, to recognise that the Supreme Court did not find this to be an absolute rule. It was to be regarded as a general principle, but there would be circumstances in which it should not apply. Examples provided by the court were:

The matter to which the challenge is directed is collateral or insignificant and fairness to the witness does not require there to be an opportunity to answer or explain.

The evidence of fact is manifestly incredible, and an opportunity to explain on cross-examination would make no difference.

The expert report contains a “bold assertion of opinion” without reasoning to support it (“bare ipse dixit”), although this should be distinguished from reasoning which appeared inadequate and was open to criticism for that reason.

An obvious mistake on the face of the expert report.

The witnesses’ evidence of the facts are contrary to the basis on which the expert expressed his or her view in the expert report.

Where an expert has been given a sufficient opportunity to respond to criticism of, or otherwise clarify his or her report, for example, through questions under CPR Part 35.6.

A failure to comply with the requirements of CPR PD 35.

It was found that none of the exceptions applied in this matter. Although CPR Part 35 questions had been put to the expert, they were not sufficient to properly put the claimant on notice of the challenge being made to the evidence. They had not provided opportunity for the expert to explain his evidence, sufficient to negate the need for cross-examination.

In dismissing the defendant’s argument that requiring cross-examination would lead to a disproportionate increase in legal costs, the Supreme Court observed that, in low value cases, where deficient medical evidence is relied upon, a defendant had the opportunity to address the deficiencies through targeted questions under CPR Part 35, clearly setting out the challenges and providing sufficient opportunity for the expert to respond, thereby keeping the costs associated with defending matters of this nature proportionate. 

Comment

The Supreme Court has clarified the way in which disputed evidence, not only expert evidence, should be handled. Parties must challenge clearly and allow sufficient opportunity for response.

This is consistent with the requirement that cases are dealt with justly. Under the CPR, however, cases must not only be dealt with justly but also at proportionate cost. Requiring experts in low value claims to give oral evidence at trial significantly increases costs. The clear instruction from the Supreme Court is that parties must ensure that full and effective use is made of any questions under CPR Part 35 in such cases, rather than raising challenges at the end of trial.

The exceptions cited by the Supreme Court are wide-ranging, however. It is not at all difficult to imagine that arguments will arise over whether, for example, an expert report contains the bare assertion of opinion without adequate justification, or whether a party’s questions posed under CPR Part 35 provided an expert with adequate opportunity to address criticisms of the evidence.

As is so often the case, firmly closing one area of dispute may prove to result in the creation of new issues for parties to fall out about. We suspect that the ripples from TUI Limited v Griffiths will run on for some time to come. 

This article looks at current trends in UK mid-market debt finance and what we anticipate for 2024.

Businesses have faced a perfect storm of challenges in the last twelve months: slow economic growth, rising interest rates, geopolitical unrest and struggles to curb inflation.

Despite all that, Q4 of 2023 was a busy one, with a definite uptick in new deals off the back of more positive economic news towards the end of the year.

With green shoots in the economy bringing deals out of hibernation, challenges in other markets providing opportunity, and a willingness amongst stakeholders to look at different debt structures, we step with cautious optimism into 2024.

General market and economic challenges

The increase in the cost of debt resulting from interest rate rises slowed the market in 2023. Whilst economists aren’t predicting a sharp decrease, it does look as if rates may have peaked or at least plateaued. An ability to map out likely debt costs should provide some confidence.

On a domestic level, inflation has slowed and economic growth levels were not as bad as had been feared. That said, rates of company insolvencies increased in 2023 vs the year before (although this may form part of a ‘catch up’ following particularly low levels during the pandemic). Some economists have suggested fragile conditions may have masked a downturn in business performance.

It is impossible to ignore the dreadful events happening overseas which will undoubtedly impact things closer to home. Coupled with elections in the UK, US, India and across Europe this year, the geopolitical climate is particularly unsettled. As well as being unnerving, events will push up prices, impact regulation and mute appetite in some sectors.

However, the challenges have also brought opportunity for some – private capital and acquisitive businesses have seen some easy wins thanks to the natural caution of bank credit and increased debt costs. It was less than a year ago that Silicon Valley Bank collapsed; what seemed catastrophic has been a success story for HSBC. Some even predict the reduced volume of larger leveraged deals will drive activity in the mid-market.

Market trends

We continue to see short term extensions used to buy time to allow the market to settle. Naturally some of those bring a margin increase and we’re also seeing bullet loans amended to amortise to allow extra flexibility. It seems likely that the volume of event driven deals in the mid-market will remain dampened. When new money deals do get the go ahead, they’re often at full throttle to minimise market movements during the execution phase.

2024 will likely see a continued increase in refinancings as loans reach maturity, lender appetite to amend & extend diminishes, and shareholders look to refinance capital they have fronted in recent months.

In terms of sector trends, tech remains front of pack, along with businesses with an environmental, social and governance (ESG) spin. Our real estate colleagues have seen this too, with data centres and lab space still being battled over as AI and life sciences continue to defy a downturn.

We have seen an uptick in public to private transactions as private equity investors (and in some cases management teams) use the dip in the market to take private those public companies in which they see investment potential.

As many stakeholders we have spoken to recently have recognised, seller aspirations remain high, but the cost of finance for buyers is fast becoming a leveller. Aggressive term sheets aren’t so well received from anyone other than the strongest borrower. Given the change in appetite for lending, expectations have had to change.

Deal structures and document trends

The cost of bank debt means we’re seeing diverse solutions to plug funding gaps. As well as an increase in the use of equity and loan notes for acquisitions and wholesale PIK facilities, we’re seeing multiple lenders on transactions that wouldn’t have warranted it in the past, as well as debt funds providing direct lending alongside private equity.

As well as looking to shareholders to bridge funding gaps, many businesses have made the most of PIK toggle provisions to free up cash – more on this in our private equity team’s recent update.

Whilst it’s great to see the tenacity of the mid-market, these structures do come with challenges: often deals take longer because of the number of parties involved and intercreditor issues can be difficult to iron out. This is exacerbated on lends to businesses with defined benefit pension schemes, with pension trustees added to the list of creditors, and additional layers of due diligence for credit committees particularly since the introduction of The Pension Schemes Act 2021’s criminal offences which have the potential to apply to both borrowers and lenders.

For borrowers who have already been afforded the flexibility of an accordion facility, they’re an efficient inlet for the wider market (as well as existing syndicates) to assist with their increased debt needs. As predicted last year we have worked on several accordion activations in recent months. For the most successful businesses we expect to see some reduction in pricing in the early part of 2024 (compared to late 2023).

In terms of documents: equity cures have long been standard on PE backed transactions, and again these have proven an efficient mechanic to allow equity injections to those businesses that have needed a boost in recent months. We continue to see Annual Recurring Revenue financings and other innovative structures which allow growth businesses opportunity despite not meeting normal covenants.

As anticipated last year, more trying times have triggered a move back to interest cover covenants sitting alongside leverage (and others). Unsurprisingly hedging has become more widely used which does add an extra layer to intercreditor documentation.

ESG considerations

The accessibility of Sustainability Linked Loans (SLLs) means they’ve become a more prominent feature in the mid-market than Green Loans. The focus of KPIs is more often on the ‘E’ than the ‘S’ or ‘G’. From a documentation point of view, the Loan Market Association’s (LMA) SLL principles (Principles) have evolved again this year and will need to continue to evolve as this market develops in order to provide a useful benchmark for lenders looking to ensure their KPIs and testing mechanisms are sufficiently robust.

There remains a gap in the market in terms of specialists who can advise on and provide independent audits of ESG related covenants, and ESG data in the market was considered the most significant obstacle to the integration of ESG issues in the syndicated loan market in the LMA’s end of year survey, with second place going to limited availability of ESG information from borrowers.

‘Sleeper SLLs’ have become a regular feature in the market – where (usually due to time constraints) KPIs and related targets are not finalised at completion and so certain SLL provisions are triggered later. The guidance to the updated Principles provides that only in exceptional circumstances and within 12 months of completion can SLL provisions be ‘switched on’, and that in the meantime the loan cannot be referred to as a SLL.

The FCA confirmed their Sustainability Disclosure Requirements (SDR) at the end of 2023. Intended to ensure transparency, the measures introduce an anti-greenwashing rule for all authorised firms (ensuring ‘sustainability related claims are fair, clear and not misleading’) as well as product labels and naming requirements to ensure investors have a clear and honest picture of how funds are being used.

Whilst the SDR will no doubt bring about positive changes, in the shorter term we anticipate increased caution with the attention of both borrower and lender boards (and legal teams) turning to DD and reporting requirements, as well as scrutinising their own supply chains and practices.

Continued increase in regulation

2023 saw the Economic Crime (Transparency and Enforcement) Act 2022 (ECT) really bite.

Hot on the ECT’s heels is the Economic Crime and Corporate Transparency Act 2023 (ECC), which became law in October 2023. The ECC is again aimed at improving transparency, introducing liability for ‘failure to prevent fraud’, extending criminal liability for corporates to include ‘senior managers’ and changing requirements for board constitutions, filing and other identification requirements. Companies House will take on a bigger role in recording and scrutinising company information to ensure compliance with the ECC. 2024 should see secondary legislation and some significant changes at Companies House to ensure these changes can be effectively implemented.

We know that behind the scenes, changes to capital adequacy requirements (specifically Basel 3.1) are starting to impact our lender clients too, particularly those with a real estate focus. Sanctions remain a hot topic given the geopolitical climate, Consumer Duty has impacted some of our lender clients and the FCA’s new SDR (see above) all point towards a continued increase in regulation, as well as evidencing the FCA’s commitment to ensuring the UK remains a safe and forward-thinking place to do business.

Outlook and conclusion

Whilst market conditions remain tricky, and last year’s headwinds continue to apply, there is a huge amount of opportunity in the mid-market in in 2024, and we look forward to working alongside our clients to make the most of it.

]]>

In this post, Liz Jackson, Trainee Solicitor, and Max Wiktorsson, Associate, in the Employment Team at CMS, comment on the decision from the Supreme Court in Independent Workers Union of Great Britain v Central Arbitration Committee and Anor. [2023] UKSC 43. The case was heard by the Supreme Court on 25 and 26 April 2023 and judgment was handed down on 21 November 2023.

The Supreme Court held that a group of Deliveroo delivery riders were not in an employment relationship with Deliveroo, and as a result, they could not rely on the trade union rights conferred by ECHR, art 11.

The Law

Domestic Law

When an independent trade union wishes to be recognised as entitled to conduct collective bargaining on behalf of a specific group of workers, it will usually make that request directly to the employer. If the employer rejects the request, the union may seek recognition by following the statutory procedure set out in the Trade Union and Labour Relations (Consolidation) Act 1992 (“TULRCA”), Pt I, Sch A1.

Under Sch A1, a union can make an application to the Central Arbitration Committee (“CAC”) for recognition. The CAC is a quasi-judicial body which has power to order an employer to recognise a union and engage in collective bargaining if certain conditions are met. One of the key conditions, is that the people the union seeks to represent are “workers” within the meaning of TULRCA, s 296.

S 296 states that a “worker” is an individual who works, or normally works or seeks to work (a) under a contract of employment (an “employee”), or (b) under any other contract whereby they undertake to do or perform personally any work or services for another party to the contract who is not a professional client of theirs (a “limb (b) worker”).

ECHR

Art 11 protects the right of freedom of peaceful assembly and association, it also contains a specific right to form and join trade unions. Art 11(2) states that no restrictions can be imposed on this right other than those necessary in a democratic society.

The case law of the European Court of Human Rights (“the ECtHR”) is clear that the right to form a trade union only arises in the context of an employment relationship. The concept of an employment relationship for the purposes of art 11 is freestanding and does not depend on the definitions of “worker” or “employee” used in domestic law.

International Labour Organisation (“the ILO”)

ECtHR case law states that to decide whether there is an employment relationship for the purposes of art 11, a court should have regard to the factors set out in the ILO’s Employment Relationship Recommendation, 2006 No 198. That recommendation makes clear that an employment relationship should be assessed with reference to the facts and the practicalities of the relationship, notwithstanding how that relationship is characterised in any contract or other agreement between the parties.

The Facts

A group of Deliveroo riders (“the Riders”) working in the Camden and Kentish town area of London became members of the Independent Workers Union of Great Britain (“the IWGB”). In November 2016, the IWGB made a formal request to Deliveroo to recognise the union for collective bargaining on behalf of the Riders. Deliveroo rejected the request. The IWGB then made an application to the CAC under Sch A1.

Decisions of the Lower Courts

The CAC carried out a detailed analysis of the nature of the relationship between the Riders and Deliveroo, which is discussed further below, and found that the Riders were not “workers” within the meaning of s 296. Therefore, the CAC did not accept the IWGB’s application for recognition. The CAC also rejected the IWGB’s argument that the refusal to recognise it because of the domestic definition of “worker” was in breach of art 11.

The IWGB sought permission to challenge the CAC’s decision by way of judicial review on a number of grounds. Permission was only granted for one of the grounds, that the refusal to accept the IWGB’s application for recognition for the purposes of collective bargaining was in violation of art 11.

In the appellate courts therefore, the IWGB’s challenge proceeded on the basis that the Riders were not workers under domestic law, but that they fell within the class of people protected by art 11, and that as such, the definition in s 296 should be read down pursuant to the Human Rights Act 1998 (“the HRA”), s 3, so that it included the Riders.

The High Court dismissed the IWGB’s judicial review. The IWGB appealed to the Court of Appeal, who upheld the High Court’s judgment. The IWGB appealed again to the Supreme Court.

Issues before the Supreme Court

The issues before the Supreme Court were:

Whether the Riders fall within the scope of art 11;

If they do, whether that means that Deliveroo can be compelled to engage in (compulsory) collective bargaining;

If it does, whether the fact that they had been denied that right on the basis of the definition of “worker” in s 296 is a violation of art 11; and

If there is a violation of art 11 because of the definition of “workers”, whether that definition can be read down under s 3 so as to include the Riders.  

Supreme Court Decision

The Supreme Court unanimously dismissed the IWGB’s appeal. It held that the Riders were not in an employment relationship for the purposes of art 11. Therefore, the provisions of art 11 which protect trade union activity do not apply to them. The CAC’s decision to reject the IWGB’s application was upheld.

The Supreme Court emphasised that the concept of an employment relationship for the purposes of art 11 is freestanding and does not depend on the definitions of “worker” or “employee” used in domestic law. When making an assessment of an employment relationship in this context, a court should have regard to the factors set out in the ILO’s Employment Relationship Recommendation, 2006 No 198.

The Supreme Court stated that the CAC had rigorously scrutinised the substance of the relationship between Deliveroo and the Riders. It examined in detail how the contract between Deliveroo and the Riders (a new contract had been introduced shortly before the CAC hearing, which included the substitution clause discussed below) operated in practice and whether the provisions in that contract genuinely reflected the true relationship between the parties. In particular, the CAC found:

The contract gave the Riders a broad and “virtually unfettered” right to appoint a substitute to do their job for them;

Deliveroo did not police the Riders’ decision to use a substitute, and Riders were neither criticised nor sanctioned for doing so; and

Deliveroo did not object to Riders working for its competitors.

The CAC was entitled to conclude that the provisions in the contract genuinely reflected the reality of the relationship and that that was not an employment relationship. As the Riders do not have an employment relationship, they are not able to rely on the trade union rights conferred by art 11.

As the Supreme Court found that the Riders did not fall within the scope of art 11, which was the first issue, it did not have to decide the issue of compulsory collective bargaining. However, as it recognised that there is a lack of clarity in the case law, the Supreme Court went on to look at whether the ECHR requires the UK to legislate to require employers to engage in collective bargaining with unions.

The Supreme Court considered a number of decisions by the ECtHR, including Unite the Union v United Kingdom [2017] IRLR 438, in which it was held that member states have a wide margin of discretion in how they protect trade union freedom. Art 11 does not confer a right to compulsory collective bargaining, so whilst states are free to provide rights that go further than the ECHR requires, as the UK has done by enacting Sch A1, a state will not be in breach of art 11 if it declines to legislate for compulsory collective bargaining as long as there is an ability voluntarily to enter into collective bargaining.

Comment

The Supreme Court’s decision in this case is a landmark decision for the gig economy. It means that individuals working in the gig economy under contracts with substitution clauses may be more likely to not be classed as workers. If they fall short of the worker definition, they are excluded from several rights under UK employment protection legislation, such as rights afforded to workers under the Employment Rights Act 1996, the Equality Act 2010, the National Minimum Wage Act 1998 and the Working Time Regulations 1998 (SI 1998/1833).

However, a nominal substitution clause in a contract is not enough to avoid worker status, it must be a genuine substitution clause. The courts will look beyond how a relationship is formally described in a contract and consider the reality of the relationship.

In Pimlico Plumbers Ltd and Mullins v Smith [2018] UKSC 29, the Supreme Court held that the sole test in deciding whether someone is a worker is whether there is an obligation of personal performance. In Pimlico, it was held that the plumbers were workers even though there was a substitution clause, as the reality was that the only workers who could be substituted were other workers that were contracted to the company. This can be contrasted with the Deliveroo Riders’ unfettered right of substitution.

This decision may seem at odds with the decision in Uber BV and others v Aslam and others [2021] UKSC 5, in which Uber drivers were found to be workers rather than self-employed. However, Uber did not concern art 11 rights nor was there a substitution clause.

There may be change on the horizon, as the Labour Party has committed to, if it wins the next general election, removing the distinction between employees and workers to create a single status for all but the “genuinely self-employed”. Whether that will change anything remains to be seen, as similar difficulties with deciding who is “genuinely self-employed” will remain and employers who want to avoid the people working for them being classified as workers will always try to change their arrangements to avoid a finding of worker status. In the EU, the Platform Work Directive, which is yet to become law, will aim to ensure the correct classification of the employment status of people performing platform work. This, of course, will not be binding in the UK but may be influential nonetheless.

In this post, Jaspal Pachu, Graham Muir and Jasleen Kaur at CMS comment on the Supreme Court’s decision in His Majesty’s Revenue and Customs v Vermilion Holdings Ltd [2023] UKSC 37, which was handed down on 25 October 2023.

Background

In 2006, Vermilion Holdings Ltd (“Vermilion” or “the Company”) carried out a funding exercise as part of which Quest Advantage Limited (“Quest”) was appointed to produce a business plan and financial projections and Dickson Minto was appointed as legal advisor to assist with the fundraising. Vermilion granted a “supplier option” to each of Quest and 22 Nominees Ltd (Dickson Minto’s nominee) to acquire ordinary shares in the Company in consideration for the services provided by Quest and Dickson Minto. The “supplier options” were not considered to be employment-related securities options within the meaning of Income Tax (Earnings and Pensions) Act 2003, s 471(5) (“ITEPA”).

By January 2007, it transpired that the Company was not generating any income and was running out of working capital. Mr Noble (a director of Quest) highlighted that the Company needed another fundraising round to continue trading. The 2007 fundraising round had notable pre-conditions:

to appoint Mr Noble as executive chairman of the Company; and

to amend the “supplier options” held by Quest and Dickson Minto to reduce their respective share entitlements.

However, the Company did not vary the terms of the existing options, but instead granted each of Quest and Dickson Minto a new option on 2 July 2007. The option granted to Quest was now over F ordinary shares over a maximum of 1.5% of Vermilion’s issued share capital. It was a condition of the new option that the 2006 option would lapse on the grant of the 2007 option.

Almost a decade later, in the context of a proposed sale of the Company, the 2007 option was novated by Quest to Mr Noble who then exercised the option. Shortly thereafter, Mr Noble and Vermilion sought confirmation from HMRC that the gain realised on the exercise of the 2007 option and sale of the resulting shares was subject to capital gains tax (rather than income tax/NICs). HMRC determined that the exercise of the option was a chargeable event pursuant to ITEPA, Pt 7 and that the option gain therefore counted as Mr Noble’s employment income for the purposes of ITEPA and, accordingly, HMRC assessed Vermilion to the resulting tax and NICs under PAYE (which Mr. Noble had indemnified the Company for).

The relevant legislation

For the purposes of this appeal, the critical legislation is set out in ITEPA, s 471, which provides that:

“(1)       This Chapter applies to a securities option acquired by a person where the right or opportunity to acquire the securities option is available by reason of an employment of that person or any other person.

(2)         For the purposes of subsection (1) “employment” includes a former or prospective employment.

(3)         A right or opportunity to acquire a securities option made available by a person’s employer, or a person connected with a person’s employer, is to be regarded for the purposes of subsection (1) as available by reason of an employment of that person unless—

a. the person by whom the right or opportunity is made available is an individual, and

b. the right or opportunity is made available in the normal course of the domestic, family or personal relationships of that person.”

Accordingly, there are effectively two tests set out in ITEPA, s 471, which, if either is satisfied, will result in the exercise of a securities option being subject to income tax rather than capital gains tax. The first test, in subsection (1), is a test of causation, asking whether the right or opportunity to acquire the securities option “is available by reason of an employment of that person or another person”. The second test, in subsection (3), purports to eliminate the need to establish a causal link where a person’s employer makes a right or opportunity to acquire a securities option available to the employee, in which circumstances the causal link is deemed to exist.

The lower courts considered and applied the tests set out in ITEPA, s 471 in a slightly different manner, thereby reaching a different conclusion each time but, in each case, either focussing on, or giving material weight to, the operative cause of the grant of the 2007 option. However, the Supreme Court’s decision took a very different approach to the interaction of s 471(1) and s 471(3), determining in favour of HMRC on the basis that, once the deeming provision in s 471(3) was engaged, there was no need to then qualify or test this by looking at the operative cause of the grant of the relevant option.

Appellate history

The First-tier Tribunal held in favour of the taxpayer. It determined that the scope of the deeming provision should be limited “where the artificial assumption from deeming is at variance with the factual reason that gave rise to the right to acquire the option”. It concluded that the grant of the 2007 option was ‘made available’ by Mr Noble’s surrender of his 2006 option and he did not as a matter of fact acquire the 2007 option ‘by reason of his employment’ and accordingly the 2007 option should not be treated as an employment-related securities option.

The Upper Tribunal overturned the decision of the First-tier Tribunal and held in favour of HMRC, finding that the FTT had erred in law. The Upper Tribunal decided that Mr Noble’s employment (i.e., his directorship of Vermilion) was an operative cause of the grant of the 2007 option as it was a condition of the grant of the 2007 option that Mr Noble would become a director. As such, pursuant to ITEPA, s 471(1), the 2007 option was an employment-related securities option. Given this conclusion, the Upper Tribunal had no need to consider the application of the deeming provision set out in subsection (3) and did not do so.

The Court of Session Inner House, by majority, reinstated the First-tier Tribunal’s decision finding in favour of the taxpayer. It stated that the 2007 option had been made available by the existence of the 2006 option and that Mr Noble’s directorship of Vermilion was not a sufficiently operative cause of the 2007 option being granted to engage ITEPA, s 471(1). Further, Lord Doherty considered that it would be “anomalous, absurd and unjust” to treat the opportunity to acquire the 2007 option as being made available by reason of Mr Noble’s employment so as to engage ITEPA, s 471(3). The Court of Session further stated that it was an error to categorise ITEPA, s 471(3) “as a separate and distinct route to taxation” which is available even if it has been established that ITEPA, s 471(1) has no application (i.e. there is no direct causal link between the relevant employment and the option being made available).

Decision of the Supreme Court

The Supreme Court upheld HMRC’s appeal, finding that the 2007 Option was an employment-related securities option. In a surprisingly short judgment, which leaves a number of key questions unanswered, the Supreme Court has given some direction on the interpretation of ITEPA, s 471(3) and the circumstances in which it applies. Lord Hodge who gave the only judgment (with which Lord Lloyd-Jones, Lord Leggatt, Lord Burrows and Lady Rose agreed) stated (at [33]):

“.. the purpose of section 471(3) is to circumvent the difficult issues that can arise in the application of section 471(1). The statutory provision makes it clear that if an employer makes available to an employee a securities option, that option will be treated in the employee’s hands as an employment-related securities option and taxed accordingly.”

It was noted that, in interpreting ITEPA, s 471, the lower courts had focused on the meaning of “by reason of employment” in subsection (1) to try to establish a “causal” connection, thus requiring them to grapple with difficult questions of causation and, perhaps unsurprisingly, coming to different conclusions. Instead, the Supreme Court found that ITEPA, s 471(3) creates a straightforward ‘bright line rule’ being that if an employee is granted an option (or, more precisely, if the right or opportunity to acquire the option is made available) by their employer (or a person connected with the employer), that option is conclusively treated by ITEPA, s 471(3) as an employment-related securities option. That, in the view of the Supreme Court, reflects Parliament’s specific intention behind the insertion of the deeming provision, i.e., avoiding the need for the courts to consider complex questions of causation raised by ITEPA, s 471(1) where the deeming provision in ITEPA, s 471(3) applies. Therefore, the only point on which the Supreme Court considered it necessary to opine, to determine whether HMRC’s appeal should be upheld, was whether Vermilion (as employer) made the 2007 option available to Mr Noble whilst he was a director (and hence deemed for income tax purposes to be an employee) of Vermilion.  The answer was, in the view of Lord Hodge, a rather simple yes on the facts and, as such, HMRC’s appeal was allowed.

The Supreme Court cited with approval its previous guidance given in the case of Fowler v Commissioners for Her Majesty’s Revenue & Customs [2020] UKSC 22 on the application of deeming provisions in legislation. Lord Briggs in that case stated that:

“(1) The extent of the fiction created by a deeming provision is primarily a matter of construction of the statute in which it appears.

(2) For that purpose, the court should ascertain, if it can, the purposes for which and the persons between whom the statutory fiction is to be resorted to, and then apply the deeming provision that far, but not where it would produce effects clearly outside those purposes.

(3) But those purposes may be difficult to ascertain, and Parliament may not find it easy to prescribe with precision the intended limits of the artificial assumption which the deeming provision requires to be made.

(4) A deeming provision should not be applied so far as to produce unjust, absurd or anomalous results, unless the court is compelled to do so by clear language.

(5) But the court should not shrink from applying the fiction created by the deeming provision to the consequences which would inevitably flow from the fiction being real.”

The Vermilion judgment removes any ambiguity in circumstances where an employee receives a share option which is made available by their employer (or a person connected with their employer). Given that Vermilion had granted the 2007 option at a time when Mr Noble was a director of the Company, the Supreme Court was satisfied that the option was made available to Mr Noble by his employer and therefore the exercise of that option rightly fell within the ambit of income tax.

Comment

In overturning the decision of the Court of Session Inner House, the Supreme Court decision tells us not to “put the cart before the horse”; the correct approach to applying the deeming provision in ITEPA s 471(3) is to ascertain ‘who’ conferred the right or opportunity for the employee to acquire the share option in the employer company rather than ‘why’ that person conferred such right or opportunity. If the right or opportunity is made available by the employer (or a person connected with the employer), the option is correctly treated as being an employment-related securities option and, in those circumstances, there is no need to consider the (sometimes difficult) questions of causation posed by ITEPA, s 471(1).  The Supreme Court opined that this sequencing in which the statutory provisions should be considered, and the consequent absence of any requirement to consider actual causation if the deeming provision in ITEPA, s 471(3) applies, reflects the intention of Parliament in enacting the deeming provision.

This week Matt speaks to Rob Moore the director and founder of blockchain and open source investigations firm Arrowsgate.

Rob, previously in the British Army, talks about his move from jumping out of planes into open battlefields to chasing criminals laundering money through blockchain analytics and helping victims of fraud get their funds back.

Matt and Rob speak about the state of play including the sad instances of human trafficking and modern slavery, the roles crypto exchanges may play in the movement of money as well as considering how the sector can clean up its act.

Listen to the podcast below and send your thoughts to matt.green@shoosmiths.co.uk.

 

]]>

Everyone is feeling it, the rumbling of a technological storm. The immergence of generative AI, RegTech and increased fraud and cyber risk, have swept clouds of uncertainty across the Financial Services Sector…. but is it all doom and gloom? Have the copious amounts of changes imposed upon the Sector in 2023 paved the way for firms to safely negotiate the 2024 storm? 

Consumer Duty

A major focus for the sector in 2023 was the implementation of the Consumer Duty. Now and throughout 2024 the Financial Conduct Authority (FCA) have a keen eye on how firms have implemented the Duty. Firms must continue to focus on making the Consumer Duty an integral part of their day to day. Firms must also consider whether they have any closed products, which require review before the July 2024 deadline. 

The FCA have also indicated that they intend to use the Consumer Duty as a framework to supervise AI risks. This includes their increased ability to monitor the Big Tech firms when they cross over into the Financial Services Sector. 

Firms must also be conscious of the FCA’s agenda to become more data driven and careful consideration should be given to the implementation of Product Sales Data Reporting (CP23/21) for consumer credit providers. 

Operational resilience 

A focus on operational resilience will continue throughout 2024, emphasised by the Consumer Duty requirement to protect customers from foreseeable harm. Firms should be prepared for some adjustment in this regard when the drafting of the EU’s Digital Operational Resilience Act (DORA) is finalised mid-2024, applying from the 17th January 2025. 

ESG 

ESG remains at the heart of the regulatory agenda, with further policy statements on diversity and inclusion and ESG ratings. Firms will be required to continue to demonstrate their commitment to progress towards ESG measures. 

Cryptoasset promotion

2024 may see an increased workload for the FCA in relation to cryptoassets. The implementation of the financial promotion restriction to cryptoassets was introduced in 2023. Now, cryptoasset promotion must be communicated or approved by a FCA authorised person or a registered cryptoasset business. The FCA have been clear regarding the consequences of non-compliance and may find themselves very busy investigating breaches in 2024. 

Payments

2024 will see an upgrade of interbank payment systems, with changes to improve on Faster Payments which was introduced in 2017. The Financial Services and Markets Act 2023, Payment Services Regulations 2017 (PSR) reforms are predicted to begin in early 2024. In addition, an FCA consultation is expected in line with these improvements and covering plans to replace strong customer authentication (SCA) with an outcomes-based regime. 

Open banking

Open banking shall see some changes in 2024, with the government saying that it will put forward legislation to establish a new long-term regulatory framework. This framework requires more firms to participate in a commercial model for open banking which will include enhanced consumer protection measures, purchase protection and dispute resolution. The FCA and PSR have also indicated they will consult on dispute resolution in relation to open banking in 2024.

Buy-now pay-later

Following record inflation and significant shifts in the prices of everyday goods, 2023 witnessed consumers re-evaluating their online payment methods. Buy-now pay-later (BNPL) is set to continue being the most rapidly expanding online payment method in the UK and abroad in 2024, with a growth rate predicted to be twice that of bank transfers and more than three times that of digital wallets. While BNPL schemes provide speed and convenience at checkout, users may not be aware that they are incurring debt or the consequences of missed payments. Following a lot of discussion in 2023, the government now plan to update consumer credit laws in 2024 is respect to BNPL. BNPL providers will be regulated, however they will be subject to a “lighter touch” regime.

Private equity

More deal activity is expected in 2024 as the private equity market has been largely stagnant for the past 18 months. This is thought to be due to inflationary pressures receding, buyer and seller expectations converging and an increased amount of exits as funds won’t be able to stretch past 2024. There are some themes that will shape investment in the Financial Services Sector, such as the increased investments in fintech, especially in areas like digital solutions and AI-driven solutions for risk management. It is hardly surprising that private equity executives are showing interest in businesses in which AI is being deployed in an effort to cut costs and improve efficiencies, setting apart investee companies from their competitors. There has also been an uptick in public-to-private transactions in 2023 and this trend is set to continue into 2024.

Banking

Looking to 2024 with a cautious optimism, as 2023 proved challenging due to persistent inflation and a 15-year high in interest rates/increased borrowing costs. For real estate financings, both of those negatively impacted values of real estate assets with a consequent decade low in commercial real estate transactions. For leveraged finance and alternative finance (asset based lending and trade finance) confidence has been lower with a consequent negative impact on the number of underlying transactions and desire to re-finance. Whilst 2024 will likely start the same way, there is more to be optimistic about. Inflation fell significantly towards the end of 2023 and is expected to continue falling or at least stabilising. There is also a real prospect of interest rate reductions in the latter half of 2024, to further stimulate activity. 

With an election on the horizon, that tends to mean that people are keen to get financings and/or transactions away ahead of any change that that may bring. Certain sectors that benefit from strong structural tailwinds such as Living will likely rebound the most strongly. In real estate we will continue to see opportunistic investors selectively targeting secondary and tertiary real estate as it undergoes repricing which in turn could pave the way for refurbishment to an improved sustainability standard or repurposing assets that have good fundamentals. In leveraged and corporate finance, we see a number of funds/investors with money to spend and pent up supply/demand due to lower levels of activity over the last 18 months or so. Asset based lending is expected to grow materially as it continues its rise out of the alternative market and into mainstream and as borrower confidence and desire to grow (whether by acquisition or organically) rises – the flexibility of the asset based lending product assisting materially in both of those scenarios.

Restructuring & Insolvency

The impact of increased interest rates and other economic headwinds are set to continue to impact corporates and consumers during 2024. Recent statistics show an uptick in administrations in the mid-market with Construction, Manufacturing and Retail sectors with the highest number of failures. The changed interest rate landscape will mean those businesses with debt maturing in 2024 may find refinancing a challenge. Early engagement by boards with stakeholders and professionals will always mean a wider range of options and restructuring tools will be available. Given 2023 saw a number of key rulings on the use of the relatively new Restructuring Plan procedure, we can expect to see a further increase of their use as the market consolidates its learning from those rulings. Conversely, in any challenging economic environment, there will also be opportunities for strategic investments and turnarounds.

Like 2023, the Financial Services Sector will need to focus significant time and effort ensuring compliance with the multitude of changes imposed in 2023 and those proposed for 2024. The changes appear to provide the structure needed to ensure firms, if compliant, will safely negotiate this uncertain path. 2025 will tell.

]]>

In this post, Lisa Fox, a senior associate in the litigation team at CMS, comments on the decision by the Supreme Court in London Borough of Merton Council v Nuffield Health [2023] UKSC 18. The issue before the Supreme Court was whether Nuffield Health is entitled to mandatory relief from non-domestic rates in respect of its occupation of its members-only gym under the Local Government Finance Act 1988.

Factual background

Nuffield Health acquired Merton Abbey (“the Premises”) on 1 August 2016, when it bought the business of Virgin Active. It applied to the London Borough of Merton (“Merton”) for mandatory and discretionary rate relief. The application for mandatory relief was granted initially (representing 80% of the rates otherwise payable). However, following a visit by Council officers in November 2016, Merton withdrew the relief on the basis that the Premises was not being wholly or mainly used for charitable purposes.

Nuffield Health is a registered charity which operates for the following purposes described in its Memorandum of Association: “to advance, promote, and maintain health and health care of all descriptions and to prevent, relieve and cure sickness and ill health of any kind, all for the public benefit.” Amongst other things, it runs 112 fitness and wellbeing centres, including the Premises. The facilities at the Premises are primarily available to fee-paying Nuffield Health Gym members.

Decisions of the lower courts

The issue before the judge in the High Court was whether Nuffield Health is entitled to mandatory relief from non-domestic rates in respect of its occupation of the Premises under the Local Government Finance Act 1988 (“the 1988 Act”), s 43(6)(a), which applies where:

“the ratepayer is a charity or trustees of a charity and the hereditament is wholly or mainly used for charitable purposes (whether of that charity or of that and other charities).”

The High Court found in Nuffield Health’s favour, holding that the charity is and, at all times since 1 August 2016, has been entitled to mandatory relief from non-domestic rates in respect of the Premises.

Merton appealed the High Court’s decision on four grounds:

Ground 1: the judge was wrong to hold that Nuffield Health was not required to show that the Premises were being used for the public benefit, as an aspect of showing that the Premises were being used wholly or mainly for its charitable purposes.

Ground 2: the judge failed to apply the correct standard of public benefit for Nuffield Health’s use of the Premises.

Ground 3: even if the judge had applied the correct standard, the judge erred in his evaluation of whether the public benefit requirement was satisfied.

Ground 4: the judge was wrong to conclude that the Premises were not being used wholly or mainly for fundraising.

Grounds 2 and 3 were contingent on Merton’s success on Ground 1, while Ground 4 was a free-standing ground.

By a majority (Lord Justices Jackson and Nugee, with Lord Justice Richards dissenting on Ground 1), the Court of Appeal dismissed Merton’s appeal. In respect of Ground 1 Lord Justice Jackson took a purposive approach and preferred the broader construction of the 1988 Act, s 43(6)(a) that treats the charitable purpose including the public benefit requirement as being part and parcel of the status of the charity ratepayer. Lord Justices Jackson and Nugee also preferred the arguments that local authorities are ill-suited and qualified to judge whether a charity is performing its responsibilities, and that the Charity Commission as regulator is best placed to do this. Lord Justice Nugee summarised that the question would be best framed, on the basis of statutory interpretation of the 1999 Act, s 43(6)(a) as whether the charity was using the premises for a purpose which is one of its charitable purposes (rather than whether the use constitutes the charitable purpose) [emphasis added].

Decision of the Supreme Court

The Supreme Court was asked to decide whether Nuffield Health is entitled to mandatory relief from non-domestic rates in respect of its occupation of its members-only gym under the 1988 Act.

The judgment was handed down by Lord Briggs and Lord Sales with whom Lords Kitchin, Hamblen and Leggat agreed, considering the intersection this appeal presents between charities and rating law, with public benefit being central to whether a purpose could qualify as charitable in the eyes of the law.

Charities Law

As a starting point the Lord Justices considered the principles under charity law relevant to the construction of the 1988 Act, s 43(6). There are two requirements under the Charities Act 2011 (“the 2011 Act”) to be established for a purpose to be deemed charitable, being: (i) that a body is established for the public benefit (mainly to be ascertained by reference either to its registration as a charity, or by reference to the body’s constitution, or its activities more broadly); and (ii) whether the body has any of the charitable purposes listed in the 2011 Act, s 3(1). The Supreme Court adopted the explanation of Nugee LJ in the Court of Appeal that the public benefit requirement in English charity law has two aspects to it:

the nature of the charitable purpose. For Nuffield, the purpose for which it is established is the advancement of health, and this satisfies the first aspect of the public benefit requirement; and

the scope of the public benefit. Meaning that the specified benefit is available to a sufficient section of the public, so that the provision of that benefit is for a public rather than private purpose.

The definition of the section of the public to which this benefit should relate, however broadly defined, will not be for the benefit of a sufficient section of the public if it excludes the poor (meaning those of modest means). The Lord Justices agreed that it therefore followed that the “scope” element of the public benefit requirement is satisfied by reference to the whole of the section of the public benefitted, rich and poor alike. This was correct, by reference to the analogy of private schools as reviewed in R (Independent Schools Council) v Charity Commission for England and Wales [2010] EWHC 2604 (Admin) (“ISC”). In that case the principle was explained in that the school is carrying out its public benefit requirement in providing education to all students, even those students paying full fees.

The Supreme Court also agreed with the Court of Appeal’s conclusion that only token provision was made for the poor at Nuffield’s Merton Abbey gym, but this did not interfere with the irrebuttable presumption arising from Nuffield’s registration as a charity that its health-related purposes, viewed overall, satisfied the public benefit requirement (ISC, para 195). The Supreme Court also flagged the distinction between (i) the fulfilment of the purposes of a charity and (ii) its lawful activities. The former is only a subset of the latter. A charity fulfils its purposes by doing what it was established to do. Those purposes must be exclusively charitable. In the present case that means, in a nutshell, promoting health. But most charities will also undertake incidental activities not directly concerned with the fulfilment of their purposes, but rather securing the continued existence of the charitable organisation. This might include, head office management, maintaining an investment portfolio, to name a few.

Construction of the applicable ratings law

The contention between the parties was whether the eligibility for ratings relief should be reached by a site by site assessment or whether it was adequate to demonstrate the body’s charitable purpose had sufficient connection to the activity at the site in question. The Lord Justices analysed the two-stage test under the 1988 Act, s 43(6):

Whether the ratepayer is or is not a charity; and

Whether the hereditament be used wholly or mainly for charitable purposes only.

For (i), Nuffield is a registered charity so this is satisfied (although consideration was given to the fact that it would be less straight forward if there was no registration and the constitution of the charity needed to be considered, or absent a conclusion there, an analysis of the ratepayer’s activities).

For (ii), the charitable purposes are the specific charitable purposes of the charity in question, rather than some generalised sense of charitable purpose.

It was the second stage of the test under ratings law that required an enquiry of sufficiently close connection of the sole or main use of the hereditament to the charitable purpose. The Supreme Court made it clear that such an enquiry does not require the rating authority to assume the role of the Charity Commission or the Court to decide whether those purposes are indeed charitable. However, given that it is understood that a charity cannot have non-charitable purposes, but can carry on other intra vires incidental activities, (e.g. fundraising, head office management, investment etc.) that they need not be in direct fulfilment of the charitable purpose or purposes.

On the facts of this case, the Supreme Court held that in light of Nuffield’s charitable purpose being the advancement, promotion and maintenance of health, Nuffield was found to use the Premises in direct fulfilment of the charitable purposes (agreeing with the Court of Appeal). This case therefore did not fall into the case of incidental activities as some of the case law considered, including ISC. What mattered in this case, was that the rich and poor benefitted from Nuffield’s activities in the round, even if the poor or a section of the public did not benefit specifically at the Merton Abbey gym (given membership pricing). It followed that the site was used wholly or mainly for its charitable purposes and the entitlement to mandatory relief from business rates was in tact.

Comment

The Supreme Court therefore upheld the decisions of the lower courts, although somewhat clarified the approach to be taken at this intersection between charity and ratings law, particularly in this case, where incidental activities to a charity’s purpose(s) were not in issue. This decision provides certainty to registered charities and ratings authorities alike that a site by site assessment is not required in order to establish entitlement. It is instead necessary to consider whether the premises are used wholly for the charitable purpose(s) or if there is sufficiently close connection between the sole or main use of the premises to the charitable purpose.