For the sixth consecutive year, JHA has achieved a top-tier ranking in the Legal 500 UK for Tax Litigation & Investigations. Furthermore, partner Graham Aaronson QC is selected once again for their exclusive Leading Individuals list. Associate Shofiqur Miah has been chosen as one of six Rising Stars; associates who make a material difference to the practice and who are considered ones to watch. Partner Michael Anderson is also highlighted for his key role in the teams' success. Client and peer testimonials for the guides 2020 research describe JHAs contentious tax team as technically very able and praise its ability to explain issues in an understandable manner'. They also single out its depth of knowledge and experience in EU law based tax litigation', and say that it is the common sense approach and ability to explain the issues which makes them stand out'. JHA was founded in 2013 and the firms' tax disputes team has been ranked as top-tier by both the Legal 500 and Chambers & Partners guides for tax litigation and contentious tax respectively every year since its inception. This continued success is testament to the firms' dominance in this space, which is enabled by its uniquely integrated approach that brings together the most relevant and experienced solicitors, barristers and accountants, and its close client relationships. View the full commentary on our team and lawyers by the Legal 500 UK here.
On 16 August 2019, ICSID released its latest proposals for amendment of its procedural rules for the resolution of international investment disputes. The key changes are:
ICSID Member States are meeting in November 2019 to consult on the latest draft proposals. Amendments to the ICSID Convention Rules require the approval of two-thirds of Member States, and a simple majority in the case of the Additional Facility Rules, Fact-Finding, and Mediation Rules.
The Court of Appeal recently gave its decision in Classic Maritime Inc v Limbungan Makmur SDN BHD [2019] EWCA Civ 1002. The case concerned the interpretation of an exceptions or force majeure clause and provides guidance on how correctly to apply the compensatory principle of damages.
BACKGROUND
The ship-owner, Classic Maritime, was engaged in a long contract of affreightment (“COA”) for the carriage of iron ore pellets from Brazil to Malaysia with Limbungan, the charterer. An addendum to the COA in 2014 stated that Limbungan agreed to ship iron ore pellets from either the ports of Tubarao or Ponta Ubu in Brazil to either Kelang or Labuan in Malaysia. Iron ore, supplied by Samarco, was shipped through Ponta Ubu and iron ore supplied by Vale through Tubarao.
On 5 November 2015, Samarco suspended its mining operations and ceased to supply iron ore given the bursting of a dam. Alternative and/or additional supplies from Vale were unavailable. As a result, Limbungan was unable to fulfil its shipment obligations. Limbungan claimed to be excused from these obligations citing that the dam burst fell under the exceptions clause of the contract. Classic Maritime sued for damages for breach of the COA.
FIRST INSTANCE DECISION
The trial judge found that while the dam burst made it impossible for Limbungan to perform the contract, even if it had not burst, the charterer would have defaulted anyway as there had been a collapse in the Malaysian iron ore market. Limbungan was unable to prove that ‘but for’ the dam bursting, it could and would have fulfilled the COA, and as such the judge held that it could not therefore rely on the exceptions clause.
The judge accepted that the applicable principle for assessing damages was the compensatory principle. In doing so, he took into account the reasons why the charterer was in breach of its obligations based on his previous finding. He assessed damages by comparing Classic Maritime’s position as a result of the breach, with the position it would have been in had Limbungan been able and willing, but for the dam burst, to fulfil its shipment obligations. As Limbungan would not have been able and willing to supply the cargoes regardless of the dam burst, the judge found that Classic Maritime was only entitled to nominal damages of $1 per shipment.
Following this judgement, Limbungan appealed on liability and Classic Maritime appealed the damages awarded.
COURT OF APPEAL DECISION
Regarding liability, the Court of Appeal decision upheld the interpretation of the exceptions clause and the first trial judge's finding on liability. It said there was no basis for approaching the clause as though it were a force majeure clause, and that Limbungan’s failure to perform did not ‘result from’ the dam burst: the dam burst could not fairly be said to have ‘directly affected’ the performance of Limbungan’s obligations.
The Court of Appeal also noted that the parties could have included a clause in the COA that excluded the ‘but for’ test, but that they had chosen not to. The original decision at first instance was therefore upheld.
Regarding the damages awarded, the Court of Appeal held that the correct approach required a comparison in financial terms between Classic Maritime’s actual position as a result of the breach and the position it would have been in had the contract been fulfilled. In assessing the value to Classic Maritime of the performance of the COA (regardless of why it was not carried out), the Court of Appeal held that Classic Maritime was in fact entitled to almost US$20 million in damages.
IMPACT OF THIS DECISION
This decision demonstrates that although the doctrine of frustration, force majeure and exceptions clauses share many similarities, where a provision is clearly intended as an exceptions clause, it must be interpreted on its own terms in accordance with the usual rules of contractual construction.
It also shows that although in cases of anticipatory breach it may be appropriate to take into account a party’s willingness to perform and whether, even if willing, it would have been excused from performance by particular events, in cases of an actual breach of an absolute obligation, the reason for failure to perform or subsequent impossibility are irrelevant when calculating damages.
Overall, this case is a clear warning of the need for clarity when drafting contractual clauses; parties need to ensure that the clauses that they agree and include in their contracts make their intentions explicit and cover the eventualities they require.
Limbungan is making an application for permission to appeal to the Supreme Court.
On Wednesday, 46 countries signed the Singapore Convention on Mediation at a ceremony attended by over 1,500 delegates at the Shangri-La Hotel in Singapore. As reported earlier this month, the Convention, which is officially titled The United Nations Convention on International Settlement Agreements Resulting from Mediation, aims to address the lack of harmonised framework for cross-border enforcement of settlements procured by mediation.
The full text of the Convention, which can be found here, was approved by the UN Commission on International Trade Law in June last year and was adopted by the UN General Assembly in December.
Among the Convention’s signatories are the USA, China, and Singapore, and the complete list of signatories can be found here. Notably, neither the UK nor any members of the European Union are among them. Despite this, there is something to be said for the enthusiasm of countries in Asia-Pacific (being the majority of the signatories) and their engagement with the project. This, along with various other initiatives being taken by such countries, in particular, Singapore’s commitment to investing in its dispute resolution infrastructure, could pose a serious threat to London’s dominant position in the world of international commercial dispute resolution.
Despite this, it is hoped by many across the globe that the Convention will be as much as a success for cross-border mediation as the New York Convention was for arbitration. Given that (a) the Convention will only come into force six months after it has been ratified by three signatories, and (b) each state must then adopt it into their domestic laws before it can be applicable, it will be some time before the impact of the Convention can be accurately determined.
Last week, the Serious Fraud Office (SFO) published a handbook on what it expects from organisations seeking cooperation credit in an investigation. This is the first time the SFO has formally set out written guidance to clarify how they will assess cooperation and, as such, is a key reference source for any company navigating its way through an investigation or seeking to negotiate a settlement with the SFO.
Cooperation is defined as “providing assistance to the SFO that goes above and beyond what the law requires”. Examples of this include:
· identifying suspected wrongdoing and criminal conduct together with the people responsible;
· reporting to the SFO within a reasonable time of the suspicions coming to light; and
· preserving available evidence and providing it promptly in an evidentially sound format.
Extensive guidance is given in the handbook on preserving and providing material to the SFO, the SFO’s aim being to ensure corporations collect all relevant evidence, maintain its integrity, and present it a way that facilitates the SFO’s ability to review it. Additionally, the SFO also encourages corporations to alert them to, and even provide them with, ‘material that the organisation cannot reach’ such as private or third-party emails and bank accounts. If corporations have such information and it is relevant, then they should, as a matter of course, seek legal advice on the sharing of personal data and data privacy.
Regarding industry and background information, the handbook suggests that corporations who ‘identify potential defences that are particular to the market or industry at issue’ would be deemed cooperative. However, the SFO’s appeal for the provision of information on ‘other actors in the relevant market’ could violate confidentiality clauses or result in questions as to how and why such data was obtained. Again, legal advice should be sought as a matter of course before providing disclosure on third-parties.
The guidance strongly encourages companies to consult the SFO before any individuals are interviewed or any action taken. Depending on the size and nature of the corporation and the issue at hand, this approach could prove difficult for companies to do while maintaining their business operations. This is only guidance; there is scope to discuss and negotiate with the SFO to ensure that commercial operations can continue as uninterrupted as possible.
Finally, the guidance emphasises that corporations should waive legal privilege on notes and transcripts of witness interviews to be deemed genuinely cooperative, with the handbook stating that if a corporation does not waive privilege, it could impact their eligibility for a Deferred Prosecution Agreement. However, corporations and their counsel will no doubt continue to battle with the SFO over access to such materials on the basis of legal privilege.
Despite all the examples of cooperation provided in the handbook, there is no guarantee that if a company follows them that this conduct will be taken into account in an investigation. Indeed, the handbook provides no examples of any actual benefits that cooperation could bring to a corporation. As such, while the report is useful in making clear what the SFO expects, it is not necessarily incentivising to ensure these expectations are met.
Following several years’ effort by a working group of the United Nations Commission on International Trade Law (UNCITRAL), including with input from as many as 85 countries and 35 Non-Governmental Organisations, a draft legal framework for international commercial mediation has been concluded. The framework consists of a Convention on the Enforcement of Mediation Settlements (together with a corresponding Model Law) which is understood to be named the Singapore Mediation Convention.
The initiative, which stemmed from a concern as to the enforceability of mediated settlements, aims to remove the potentially lengthy and difficult processes that parties who participate in an international meditation might currently face when attempting to enforce the outcome in a foreign jurisdiction (such a process would typically involve first obtaining a court judgment before any necessary enforcement procedures).
Consequently, the aim of the Convention is to implement an international regime for the enforcement of mediated settlements that is broadly similar to the successful 1958 New York Convention for the enforcement of arbitral awards and which will make it easier for businesses to enforce mediated settlement agreements with their cross-border counterparts. It is hoped that this will increase the credibility, and therefore attraction, of mediation for international parties.
The Convention will be open for signature from 7 August 2019 and it is understood that representatives from at least 50 countries across the globe will be attending the ceremony which is to be held in Singapore. Of these countries, around half (including the USA and China) have indicated that they will sign the Convention. It will then come into force once it has been ratified by at least three of the signatories.
General Dynamics United Kingdom Limited v. The State of Libya [2019] EWCA Civ 1110
In a recent decision, the Court of Appeal has held that the Courts may order that the formal rules of service can, where appropriate, be dispensed with when a party is seeking to enforce an arbitration award against a State. The decision also comes as a warning to States that they will not necessarily enjoy some of the protections to enforcement proceedings that they may once have had if they have already participated in, or indeed have refused to participate in, the initial proceedings or if there are special circumstances at play: the decision shows the English Court’s willingness to bypass at least some of the usually required formalities of service where effecting proper service would be in a real way overly problematic, risky or lengthy
Background
In 2016 the Claimant obtained an ICC arbitration award against Libya in the amount of £16 million. Following Libya’s failure to pay and following an unsuccessful attempt to enforce the award in the USA, the Claimant sought instead to seek enforcement in England.
In 2018, the Claimant obtained an Order from the Commercial Court permitting it to enforce the Award in England and, due to the serious internal conflict in Libya and issues relating to its proper and rightful government, permitting it to dispense with formal service. Instead, the Order was required to be brought to the attention of Libya by the sending of it to three specific addresses – which it was.
Within time, Libya applied to set aside the parts of the order that dispensed with service, arguing that service of court proceedings is governed by S.12(1) of the State Immunity Act 1978 (the “SIA”), which provides that "Any writ or other document required to be served for instituting proceedings against a State shall be served by being transmitted through the Foreign & Commonwealth Office to the Ministry of Foreign Affairs of the State".
Males LJ agreed with Libya and concluded that the court has no power to dispense with service in a case such as this and that arbitration enforcement proceedings (and all other documents relating to instituting proceedings against a state) must be served in the manner provided for in s.12(1) SIA (i.e. through the Foreign and Commonwealth Office (the “FCO”)).
The Claimant appealed the decision to the Court of Appeal, arguing that neither the Order nor the Claim Form initiating the enforcement proceedings were documents to which s.12(1) SIA applied.
The Decision
The Court of Appeal allowed the appeal in part, restoring the earlier Order of the Commercial Court and holding that, despite the earlier decision of Males LJ, the Claimant could dispense with formal service against Libya.
In making its decision, the Court of Appeal considered that when a State is first sued, it is natural that the document “instituting proceedings” should be served through the FCO, as required by s.12 SIA. However, if the State then fully participates in the subsequent arbitration or litigation (as Libya did in this case), or even if it deliberately refuses to participate, it no longer requires the protection of enforcement proceedings being transmitted through the FCO. In the Court’s view, neither the Order nor the Claim Form initiating enforcement proceedings was analogous to a document “instituting proceedings.”
The Court of Appeal went on to find that while an order permitting enforcement of an arbitral award must still be served on a State, service does not need to follow s.12 SIA and thus, in appropriate cases, an English court may dispense with the normal rules of service. For example, when the order permitting enforcement of an award is to be the first time that the State receives notice of an attempt to enforce, an English court can dispense with formal service where there are “exceptional circumstances” (under Civil Procedure Rule 6.16). Given the internal conflict and danger within Libya, and the considerable length of time any such formal service might take, the Court of Appeal held that exactly such exceptional circumstances existed in this case.
However, protection remains in place for States even where formal service may be ordered to be dispensed with: the Court of Appeal concluded that even where the court permits a relaxation of the rules of service, as it did in this case, States will still be given a period of time (usually two months) in which to challenge an order permitting enforcement of an arbitral award, with no risk of execution against its assets in the meantime.
On 10 April 2019 the Supreme Court issued its judgment in Lungowe and Ors v Vendanta, ruling that claims brought by a group of Zambian citizens against a Zambian mining company and its UK-domiciled parent can proceed to trial in England. The case raises important issues regarding jurisdiction and the potential liability of parent companies in respect of damage caused by their subsidiaries.
In 2015 1,826 residents of the Zambian city of Chingola filed claims alleging that they have suffered damage as a result of toxic discharges from one of the world’s largest copper mines. The mine is owned and operated by the second defendant, Konkola Copper Mines plc (“KCM”), a Zambian company. The first defendant is KCM’s ultimate parent company, Vedanta Resources plc (“Vedanta”), which is domiciled in England. The claimants allege that both Vedanta and KCM are liable under Zambian law for negligence and breach of statutory duty. Vedanta’s alleged negligence is based on its alleged failure to exercise reasonable care in monitoring and controlling KCM.
The claimants served the proceedings on Vedanta within the jurisdiction, relying on Vedanta’s English domicile and article 4 of the Recast Brussels Regulation. The claimants obtained permission to serve KCM out of the jurisdiction, on the basis that it is a “necessary or proper party” to the proceedings against Vedanta. KCM and Vedanta challenged the jurisdiction of the English courts. In 2016, the High Court held that the claimants could bring their case in England, despite the fact that the alleged tort and harm occurred in Zambia, where both the claimants and KCM are domiciled. This decision was upheld on appeal by the Court of Appeal in October 2017. In April this year, the Supreme Court unanimously dismissed a further appeal by the defendants, upholding the Court of Appeal’s ruling in all but one respect.
The Supreme Court held that the claimants are entitled to rely on article 4 of the Brussels Regulation to establish jurisdiction in respect of Vedanta. In particular, it is not an abuse of EU law, in a case where there is a triable issue against an English company, to state that the English defendant must be sued in its country of domicile (England), even if one of the principal reasons (although not the sole reason) the case is brought against it in England is so that another defendant can be brought into the jurisdiction, using the English defendant as an “anchor”. If, in doing so, the claimants themselves cause a risk of inconsistent judgments, that is a matter for the claimants.
A crucial question to determine was whether Vedanta sufficiently intervened in the management of the Zambian mine to have incurred a common law duty of care to the claimants, or a fault-based liability under the Zambian environmental, mining and public health legislation. The Supreme Court did not accept the general principles of “parent company liability” advanced by either party, but reiterated that each case must be considered on its own facts, which may (or may not) need to be considered at a full trial after disclosure. In this case, the Court considered that Vedanta would arguably owe the claimants a duty of care, on the basis of the principles articulated in Dorset Yacht Co Ltd v Home Office [1970] AC 1004 (and that the breach of statutory duty claims are also arguable).
Although the Supreme Court considered that Zambia would be the proper place for the hearing of the claims (Vedanta having offered to submit to the jurisdiction of the Zambian courts), the Court upheld the Judge’s finding that there was a real risk that the claimants would not be able to obtain substantial justice in Zambia. No criticism was made of the independence or competence of the Zambian judiciary, nor of the civil law procedures in Zambia. Rather, the Court considered a real risk arose because (i) legal aid would not be available, conditional fee agreements are illegal, and the claimants are too poor to fund legal representation; and (ii) Zambia lacks legal teams of sufficient size and experience to pursue mass claims of this nature effectively.
The effect of the judgment is that the claims against both Vedanta and KCM can proceed in England. The judgment potentially has wider implications, given the number of English-domiciled corporations which operate through overseas subsidiaries around the world. In particular, English parent companies who make public commitments relating to their responsibilities to communities and the environment and then fail to put these into practice, may find themselves facing claims brought by non-UK claimants in the English courts.
Legal professional privilege is a cornerstone principle of the English legal system. Last year, the Court of Appeal issued a landmark decision on the doctrine of legal professional privilege. The case, The Director of the Serious Fraud Office v Eurasian Natural Resources Corporation Limited [2018] EWCA Civ 2006 (“ENRC”), partially overturned the decision of the High Court which had narrowed the scope of legal professional privilege in internal investigations. The Court’s decision had the effect of permitting documents prepared as part of an internal investigation to be protected by litigation privilege in certain circumstances. This article considers the findings of the Court in ENRC and subsequent developments.
Background to ENRC
This case arose after allegations of corruption and wrongdoing within a subsidiary of ENRC. After receiving an email from a whistle-blower in December 2010, ENRC launched an internal investigation into the allegations. In August 2011, the SFO wrote to ENRC urging it to consider the SFO’s Self-Reporting Guidelines, and in April 2013, the SFO launched a formal criminal investigation. The SFO subsequently sought declarations that ENRC could not resist disclosure of certain documents generated by ENRC’s solicitors and forensic accountants during its internal investigation. ENRC asserted that the documents, which included notes of interviews taken by ENRC’s solicitors with employees and former employees of ENRC, and materials generated as part of a books and records review conducted by forensic accountants, were the subject of legal advice privilege and/or litigation privilege. In a 2017 judgment, Andrews J of the High Court held that the documents were not protected by legal professional privilege. ENRC appealed.
Court of Appeal Judgment
Litigation Privilege
In order for documents to be protected against disclosure under litigation privilege, the documents must be prepared for the dominant purpose of conducting adversarial proceedings at a time when proceedings were reasonably contemplated. The Court of Appeal held that Andrews J had erred in determining that criminal legal proceedings against ENRC or its subsidiaries or their employees were not reasonably in contemplation at the time the relevant documents were created.
The Court noted that not every expression of concern by the SFO could be regarded as adversarial litigation, thereby giving rise to litigation privilege, and emphasised that each case turns on its own facts. However, the Court held that when the SFO “specifically makes clear to the company the prospect of its criminal prosecution (over and above the general principles set out in the [Self-Reporting] Guidelines), and legal advisers are engaged to deal with that situation… there is clear ground for contending that criminal prosecution is in reasonable contemplation.” Importantly, the Court also clarified that the lack of certainty as to whether proceedings are likely does not in itself prevent proceedings being in reasonable contemplation. Thus, the Court allowed ENRC’s appeal on this point, holding that criminal legal proceedings were reasonably in contemplation by ENRC when it initiated its investigation in April 2011, and certainly by the time it received the SFO’s August 2011 letter.
The Court also allowed ENRC’s appeal against Andrew J’s finding that none of the documents were brought into existence for the dominant purpose of resisting contemplated criminal proceedings. The Court held that in both the civil and criminal context, legal advice given so as to head off, avoid or even settle reasonably contemplated proceedings is as much protected by litigation privilege as advice given for the purpose of resisting or defending them. Furthermore, the Court held that the need to investigate the existence of corruption was, in this case, a subset of the defence of contemplated legal proceedings and therefore fell within the scope of litigation privilege. The Court also held that ENRC had not waived privilege in relation to the documents in issue as it had never agreed to share the results of the investigation with the SFO.
Accordingly, the Court held that substantially all of the documents were subject to litigation privilege and were therefore protected against disclosure.
Legal Advice Privilege
The Court also examined the current law regarding legal advice privilege. This form of privilege protects confidential communications between a lawyer and their client for the purpose of giving or obtaining legal advice, regardless of whether litigation is in contemplation. In particular, the Court considered the meaning of Three Rivers (No 5), a leading case on who the “client” is for the purpose of legal advice privilege, finding that the case decided that communications between an employee of a corporation and the corporation’s lawyers could not attract legal advice privilege unless that employee was tasked with seeking and receiving such advice on behalf of the client. The Court opined that Three Rivers (No 5)—which is out of step with the law of other common law jurisdictions—puts the modern corporation in a less advantageous position than individuals or smaller businesses seeking legal advice. In particular, the Court opined that lawyers for these latter groups would ordinarily obtain information about the case directly from the individual or from board members, whereas in the case of large national or multinational corporations, “the information upon which legal advice is sought is unlikely to be in the hands of the main board or those it appoints to seek and receive legal advice.” Thus, it held that if it had been open to it to depart from Three Rivers (No. 5), it would have been in favour of doing so, but that this was ultimately a matter for the Supreme Court.
Practical Implications of the Case
The Court of Appeal’s holding on the wide scope of litigation privilege will have been welcomed by companies wishing to proactively address allegations of criminal wrongdoing. While it will depend on the facts of each case whether or not documents fall within the scope of litigation privilege, the Court’s judgment made it clear that it can apply even prior to an investigation by the SFO. This is sensible: as the Court emphasised, it is “obviously in the public interest that companies should be prepared to investigate allegations from whistle blowers or investigative journalists, prior to going to a prosecutor such as the SFO, without losing the benefit of legal professional privilege for the work product and consequences of their investigation.” Furthermore, the Court’s express invitation for the Supreme Court to overturn Three Rivers (No 5) is significant in giving new force to arguments for a wider construction of legal advice privilege—one that is more fitting to modern commercial realities. However, as the SFO has announced that it will not be appealing the case, we will need to wait until another case comes along for this issue to be reconsidered.
Subsequent Developments
The Court of Appeal’s decision in ENRC has been considered in recent cases, including WH Holding Ltd v E20 Stadium LLP [2018] EWCA Civ 2652 and Glaxo Wellcome UK Ltd v Sandoz Ltd [2018] EWHC 2747 (Ch).
WH Holding Ltd v E20 Stadium LLP
In WH Holding Ltd v E20 Stadium LLP, the parties were involved in litigation arising pursuant to a contract between them. The appellants, West Ham, appealed against the dismissal of their application under CPR r.31.19(6)(a) for the Court to inspect six emails in respect of which privilege had been asserted by the respondent, E20. The emails had been sent between E20's board members, and between the board members and stakeholders. E20 claimed litigation privilege on the basis that the emails had been composed with the dominant purpose of discussing a commercial proposal for settling the litigation. Relying on the Court of Appeal’s decision in ENRC, Norris J had held that the emails were protected by litigation privilege on the basis that a document did not have to be concerned with obtaining advice or information for use in litigation in order to be protected by litigation privilege. Rather, he held that the privilege would protect documents prepared for the dominant purpose of formulating and proposing the settlement of litigation that was either in existence or in reasonable contemplation.
The Court of Appeal upheld West Ham’s appeal and ordered disclosure of the disputed documents. The Court held that litigation privilege was engaged when adversarial litigation was in reasonable contemplation. Further, once engaged, it covered communications between the parties or their solicitors and third parties seeking advice or information for the sole or dominant purpose of conducting the litigation. However, the Court held that they had not been shown any authority which would extend the scope of litigation privilege to purely commercial discussions. Nor, according to the Court, was there any justification for doing so as “it has always been recognised that privilege is an inroad into the principle that a Court should be able to decide disputes with the aid of all relevant material.” The Court went on to clarify that it did not consider that ENRC extended the scope of documents covered by litigation privilege, holding that the disputed documents in that case all fell within the recognised categories of advice or information going to the merits of contemplated litigation. The Court held that ENRC merely clarified that the conduct of litigation includes its avoidance or compromise, and that Norris J was incorrect in thinking that the case had gone any further.
Accordingly, the Court held that litigation privilege would protect documents in which advice or information obtained for the sole or dominant purpose of deciding whether to litigate or to settle could not be disentangled, and those which would otherwise reveal the nature of the advice or information. However, documents created with the dominant purpose of discussing a commercial settlement did not fall within the scope of the privilege. Moreover, there was no separate head of privilege covering internal communications within a corporate body.
Glaxo Wellcome UK Ltd v Sandoz Ltd
The recent case of Glaxo Wellcome UK Ltd v Sandoz Ltd also interpreted and applied ENRC – this time in relation to the question of legal advice privilege. In this case, the claimants sued the defendants for passing off their generic inhaler product as the claimants’ inhaler. The claimants applied under CPR r.31.19(5) to challenge the defendants’ claim to legal advice privilege in respect of two documents withheld from inspection. The defendants asserted that two internal emails from an employee seeking information to provide to the defendants’ external legal advisers for the purpose of giving them legal advice, and an internal email providing the requested information, were subject to legal advice privilege. Relying on ENRC, Chief Master Marsh held that communications between an employee of a company and the company’s lawyers could not attract legal advice privilege unless that employee had been tasked with seeking and receiving such advice on behalf of the client, and that the employee had to be authorised to seek and/or obtain the legal advice that was the reason for the communication. The Court held that preparatory work of compiling information by persons with no authority to seek or receive legal advice will never be subject to legal advice privilege. On the evidence, the Court held that the defendants had failed to discharge the burden on them to demonstrate an entitlement to legal advice privilege, and accordingly allowed the claimants to inspect the two emails.
It will be important to watch this space as the courts continue to interpret ENRC, and thus to clarify the scope of litigation privilege and legal advice privilege as it relates to the modern-day corporation.
The group financing exemption in TIOPA 2010 Part 9A Chapter 9 involves unlawful state aid, according to the European Commission’s final decision. The non-trading finance profits (NTFP) exemptions give an advantage to controlled foreign companies (CFCs) earning NTFP from qualifying loan relationships, as these exemptions are not available for upstream or third-party loans. In a three-stage test, the Commission considered: the selection of the appropriate reference system; the group financing exemption as a derogation from the general CFC regime; and whether the group financing exemption is justified.
The Commission has given the UK only two months to identify the beneficiaries of the aid, determine the amount of the aid in each case, and order repayment of those amounts, and only four months to complete full recovery of the aid.
The European Commission has published its final decision finding that the group financing exemption in TIOPA 2010 Part 9A Chapter 9 (‘Chapter 9’) involves unlawful state aid. The main change from its initial decision is that it now accepts that the exemption is justified as a proxy for the complex tracing exercise required by the UK capital criterion in TIOPA 2010 Part 9A Chapter 5 (‘Chapter 5’). It remains of the view, however, that the exemption from the application of the ‘significant people functions’ (SPF) criterion in Chapter 5 is unlawful.
Does the group financing exemption provide an advantage?
The Commission concluded that the exemption allowed UK companies with a controlled foreign company (CFC) earning non-trading finance profits (NTFP) from loans made to foreign group companies (qualifying loan relationships) either to:
In both cases, the NTFP exemptions gave an advantage to CFCs earning NTFP from qualifying loan relationships over CFCs earning NTFP from loans made to UK companies (upstream loans) or from loans made to third parties (money boxes). This is because the NTFP exemptions are not available for NTFP from upstream or third-party loans.
The three-stage test to establish whether the advantage is selective
1. The appropriate reference system
The first stage of the selectivity analysis is to choose the reference system. Here, the main choice was between the general corporate tax regime (as the UK government argued) and the CFC regime (chosen by the Commission in its initial decision). The Commission adhered to its initial choice. The consequence of that choice and the way the aid is defined is that the relevant comparison is a narrow one between CFCs with different types of lending.
The narrower reference system allows the Commission to focus on the specific aims of the CFC regime in assessing the different treatment. At the same time, it means that the analysis is dependent on the Commission making a convincing case that the different types of NTFP are comparable. It has the oddity that, in practice, the supposed recipients of the aid are likely to represent the vast majority of taxpayers, while the disadvantaged group which is subject (as a matter of legislative drafting) to the general rule are probably a minority of cases.
Given the structure of the legislation, the Commission followed its normal practice of ordering recovery from those benefiting from the exemption. However, given the narrow definition of the advantage granted, one is left wondering whether in theory a retrospective revamp of the legislation might not be an alternative way of removing the selectivity for the past. It is unclear what the practical impact would be as presumably most taxpayers will have done all they could to bring themselves within the exemption.
2. The group financing exemption as a derogation from the general CFC regime
The Commission’s view is that the NTFP exemptions constitute a derogation from the general UK CFC regime because they relieve UK entities with a CFG earning NTFP from a qualifying loan relationship, which have made a claim under Chapter 9, from the CFG charge otherwise borne by UK entities with a CFG earning NTFP from upstream or third-party loans.
The Commission considered that NTFP earned from qualifying loan relationships represent a higher risk category than NTFP earned from upstream or third-party loans and rejected the UK’s arguments that the three different sub-types of NTFP were not comparable. Also, the Commission rejected the UK’s argument that, if the NTFP exemptions did constitute a derogation, it was justified by the intertwined objectives of the CFG regime:
As regards comparability between NTFP earned from qualifying loan relationships and NTFP earned from upstream loans, the Commission’s analysis follows from what it believes to be the objective of the UK’s CFC regime, based on a distinction between ‘base erosion’ and ‘profit shifting’. The argument is that base erosion can be distinguished from profit shifting in that the former ‘deals with erosion of the payer’s tax base’, whereas the ‘latter deals with the recipient of the income who reduces his tax base by artificially diverting that income abroad’.
The Commission’s distinction seems rather artificial. CFC rules (according to the BEPS Action 3 report) ‘respond to the risk that taxpayers’ with a CFC can ‘strip the base of their county of residence’ by ‘shifting income into a CFC’ (emphasis added). Put at its lowest, base erosion and profit shifting are two concepts belonging to the same phenomenon. This is demonstrated by upstream lending. When it comes to such lending, the Commission arguably misses the point. The obvious risk in the case of upstream lending is that UK capital could be diverted from the UK and then lent back to the UK through a set of arrangements masterminded by UK SPFs, resulting in an interest deduction and no UK taxation.
Contrary to what the Commission appears to assume, the UK rules limiting interest deductions would not help, as there is a loss of UK tax base whatever the amount of the loan and the terms of the lending. The problem is that such a loan should not be made by the CFC at all in such circumstances.
The capital lent by the CFC is prima facie surplus to the operational requirements of the group’s overseas business, suggesting diversion of funds from the UK. There is therefore a serious prima facie BEPS concern with such lending not existing in the case of lending to the group’s CFCs. The Commission rightly rejects the argument that upstream lending per se involves diversion of profits (for example, there may simply be a timing issue while new financing arrangements are being set up), but the risk is arguably such as to justify requiring the Chapter 5 process to be gone through to show there is no BEPS. The same applies to third party lending.
Notwithstanding the way the legislation was drafted, the reality was that the general default rule applicable to almost all CFCs earning NTFP was a 25% charge (most taxpayers being content to accept the partial charge, rather than to undertake the exercises needed to gain full exemption). The exclusions from that rule were intended to protect the UK tax base from arrangements where there was a prima facie risk of BEPS.
The Commission further took the view that compliance with EU law was a condition applicable to all legislation enacted by EU member states, rather than an objective of the UK CFC rules. The Commission has a point but perhaps fails to take sufficient account of the fact that CFC charges and CFC compliance rules inherently entail different treatment, and hence a restriction on the freedom of establishment. They are therefore unlawful unless justified and proportionate to recognised general interests and are consistent with general principles such as legal certainty.
Against that background, and leaving aside the issue of the SPF criterion and Cadbury Schweppes (discussed by the Commission under justification), it is understandable that the UK government had compliance with EU law as a specific aim (as is apparent from preparatory documents) and wished, as a matter of policy, to err on the side of caution in providing rules that were proportionate, certain in their application and workable in practice. Workability for both the taxpayer and HMRC is, of course, an important aim, irrespective of the legal constraints.
3.Whether the group financing exemption is justified
The Commission noted that, under Chapter 5, NTFP will be subject to a CFC charge if either:
The Commission accepted the UK’s argument that the NTFP exemptions were justified, in relation to the UK connected capital test, as it avoided the ‘disproportionally burdensome tracing exercises’ that would be required to determine the portion of the NTFP funded with UK connected capital.
However, the Commission found that the NTFP exemptions were not justified where the SPF linked to the assets and risks giving rise to the NTFP from qualifying loan relationships were located in the UK. This was on the basis that a proxy rule was not justified because, in the Commission’s view, determining the localisation of the SPF is not an unduly complex or burdensome exercise, since profit attribution of SPF is ‘well recognised both in international and in EU regulations’ concerning CFC provisions. The decision refers to: the work in the BEPS Action 3 report; the ‘principles’ of the authorised OECD approach (AOA) adopted in the OECD’s 2008 and 2010 reports on the attribution of profits to permanent establishments; and the EU’s Anti-Tax Avoidance Directive (ATAD).
It may well be that the arguments made by the UK and other parties focused mainly on the UK capital criterion. The reality is that few taxpayers, if any, will have attempted the SPF analysis either. It may not be as straightforward as the Commission assumes.
First, the AOA (despite its authoritative sounding title) is not widely recognised across the OECD, and the practical application of the ‘key entrepreneurial risk-taking function for the attribution of risks and assets included in the 2008 and 2010 reports is far from straightforward.
Secondly, the design of CFC rules is not an area in which the OECD had done significant work before 2015 (this is acknowledged at page 9 of the BEPS Action 3 report); and the recommendations (which are not minimum standards) in the BEPS Action 3 are deliberately wide to accommodate an array of policy objectives across the OECD.
Thirdly, before ATAD, there was no obligation on EU member states to adopt CFC regimes, and the requirement under ATAD to impose tax in accordance with its terms only applies from 1 January 2019. At its minimum, this means that, before ATAD, EU law was silent on the design of CFC rules, and that the OECD had not produced significant guidance on CFC rules before 2015.
Cadbury Schweppes and compatibility with the Fundamental Freedoms and EU law
The Commission deals with Cadbury Schweppes under justification. It concludes that taxing the profits of foreign subsidiaries on the basis of SPF performed in the UK does not constitute a restriction to the freedom of establishment because it follows the ‘same principles’ underlying the AOA approach for the attribution of profits to permanent establishments.
The Commission took the view that this conclusion is consistent with the requirement in ATAD for EU member states to adopt a CFC regime. The argument is that ATAD allows member states two options for the design of their CFC rule. The first is to target specific types of profit which are taxed under the CFC rule with an exception where the CFC carries on a ‘substantive economic activity’. That exception is known as the ‘escape clause’. The second option for a CFC rule is to adopt a SPF test so that profits derived from SPF carried out in the relevant member state are subject to a CFC charge. The escape clause does not apply to the second option because, according to the Commission, ‘the EU legislature concluded that there was no need for such an escape clause to ensure compliance with the Union freedoms for an SPF based CFC rule’.
It may be correct that a CFC charge based on the SPF criterion, although a restriction on the freedom of establishment, might be justified on grounds of preventing tax avoidance and preserving the balanced allocation of taxing powers. If there are no local SPFs then in principle no profits would be attributable to the CFC, regardless of whether the CFC is properly established. However, had the legislation relied entirely on allocating profits by reference to the SPF criterion, involving a relatively novel and untested exercise, the result, almost inevitably, would have been endless transfer pricing disputes and challenges to test compliance with the EU law principles of legal certainty and proportionality.
This was at a time when the government was faced with numerous major domestic and EU law challenges. It is therefore not surprising that the legislator preferred a more straightforward solution for the vast majority of taxpayers which provided a partial CFC charge in the large majority of cases. As noted above under selectivity, this was part of the legitimate aims pursued by the UK legislator.
Does the group financing exemption affect intra-EU trade?
The Commission’s reasoning on this issue is hard to follow, given the narrow way the aid has been defined. Ultimately, though, the requirement of an effect on trade is easily met and, if the Commission is right on the other parts of its analysis, it is unlikely that it will fail here.
No legitimate expectations
The Commission concluded that there are no general principles of EU law preventing or limiting the recovery of the aid, noting that its exchange of formal letters with the UK, dealing with compliance of the UK’s pre-2013 CFC rules with Cadbury Schweppes, did not raise any legitimate expectations that the NTFP exemptions were not state aid.
Recovery and next steps
Formal publication of the decision in the Official Journal is still to follow. Notably, however, the Commission has given the UK only two months (from 2 April) to identify the beneficiaries of the aid, determine the amount of the aid in each case, and order repayment of those amounts. The UK is required to complete full recovery of the aid within four months (from 2 April).
At the time of writing, it is understood that while HMRC has contacted some taxpayers, it is still reflecting on next steps. UK groups can, however, expect case by case conversations with HMRC on their SPF position (and, possibly, also on the availability of other exemptions outside the scope of the Commission’s challenge).
Alongside any domestic discussions and procedures, taxpayers will doubtless also be considering the need for a direct challenge to the decision in the EU General Court in order to be sure of preserving their right to contest the validity of the decision itself.
This article was originally published in the Tax Journal and can be found here on their website.
