In this week’s update: Verification requirements for beneficial owners of overseas entities, FCA delays when processing change of control notifications, a Takeover Panel webinar on changes in its latest consultation, a termination right expired when not used quickly enough, Covid-19 restrictions did not amount to a force majeure event, a report on the impact of the new Stewardship Code and a consultation on changes to the UK’s equity secondary markets.
Overseas entities will need to verify their identity before registering
Regulations have been published which will impose verification requirements on overseas entities that need to register details of their beneficial owners in the UK.
Under the new regime, an overseas entity that holds certain types of real estate in the UK will need to register with Companies House and provide details of its “beneficial owners” and (in some cases) managing officers and any trusts that sit within its corporate structure. For more information, see our previous Corporate Law Update.
The new regime is already set out in law but has not yet been brought into effect. It will come into effect on a day to be decided by the Government.
The Register of Overseas Entities (Verification and Provision of Information) Regulations 2022 state that an overseas entity cannot register with Companies House unless the details of its beneficial owners and managing officers have been verified first.
The information must be verified by a “relevant person”. Broadly speaking, this includes credit and financial institutions, auditors, insolvency practitioners, external accountants, tax advisers, independent legal professionals, trust and company service providers, estate agents and letting agents.
It is a criminal offence for an overseas entity that holds the relevant type of land in the UK not to register with Companies House. In effect, therefore, the Regulations require overseas companies to retain an independent regulated person to verify the details of their beneficial owners and (in some cases) managing officers.
The Regulations will come into effect when the regime itself commences.
FCA experiencing delays in handling change of control applications
The Financial Conduct Authority (FCA) has stated that it is currently experiencing delays in allocating FCA-led notifications to case officers. It notes that there is currently a delay of approximately one and a half months between submission of a complete notification and allocation to a case officer.
FCA approval is required before a person can acquire control, or increase their level of control, over an FCA-regulated firm or its parent undertaking. Acquiring or increasing control without approval is a criminal offence.
In some cases, a person will obtain “control” for these purposes if they acquire as little as 10% of the voting rights in a regulated entity or in a group which contains a regulated subsidiary. For this reason, on a proposed acquisition, parties should, as early as possible, identify any regulated businesses in the target group and consider whether a notification needs to be made.
Parties to an acquisition involving a regulated business should ensure they take these delays into account when building their transaction timeline, including when setting any “longstop date” by which all conditions to an acquisition must be satisfied.
The FCA also notes that a substantial proportion of the notifications it receives are incomplete, and that it will process incomplete submissions on longer timelines than complete notifications. It recommends that notifiers provide all relevant information and documents in their initial submission.
Takeover Panel publishes webinar explaining latest consultation
In May, we reported that the Takeover Panel was consulting on changes to provisions of the Takeover Code (the Code) that address when parties are “presumed” to be acting in concert.
The proposed changes are very technical in nature. To assist with understanding the nature and impact of the proposed changes, the Panel has published a recording of a webinar it held on 29 June 2022, as well as separate slides.
Contract party lost termination right by not acting quickly enough
The High Court has held that a party to a contract was unable to end the contract following a failure to pay because he had not exercised his termination right within a reasonable timeframe.
DD Classics Ltd v Chen  EWHC 1404 (Comm) concerned a contract for the sale of a limited-edition Ferrari racing car. The contract stated that the sale price (which was over €3 million) was payable within five business days. This set a deadline of 24 March 2021.
The contract then stated that, if the buyer were not to make payment by then, “the seller is entitled to withdraw from this contract without reminder or setting a deadline.”
The buyer paid a small deposit but did not pay the balance by the deadline. Instead, for the next two weeks, the buyer asked for further documentation to substantiate the seller’s ownership of the car.
During this time, the seller communicated with the buyer several times via email and Whatsapp, asking the buyer to pay the balance, noting that the balance had been due within five business days, and stating that he was happy for the parties to withdraw from the sale if the buyer had changed its mind.
The buyer finally instructed payment of the balance on 7 April 2021, just over two weeks after the initial payment deadline. The payment arrived in the seller’s bank account on 9 April 2021. However, the seller’s bank declined to release the payment to the seller because the seller had failed to answer certain compliance questions the bank had raised with him.
On 15 April 2021, the bank told the seller the payment had reached his bank account, but the wording of the communication led the seller to believe that the payment would be returned to the buyer.
On 25 May 2021, having learned that the payment had not bounced, the seller instructed his bank to transfer the money to his personal holding vehicle. He claimed that he had decided to terminate the arrangement on 13 April 2021 (20 days, or 13 business days, after payment had become due) due to failure to pay when due and that he intended to transfer the money back to the buyer.
There was no doubt the buyer had failed to pay the balance when due. The key question for the court was whether the seller was entitled to exercise its contractual right to terminate the contract a full 20 days after the payment failure had taken place and when the payment had in fact, by then, been made.
What did the court say?
In short, the court held that the seller was not entitled to terminate the contract.
The judge noted that the contract allowed the seller to withdraw “without reminder or setting a deadline”. But this simply meant that the seller had not needed to give advance notice to terminate the contract. It did not mean he could exercise his right to terminate at any time after the failure to pay.
The seller had argued that 13 business days was a reasonable period to exercise his termination right. The court disagreed, noting that what mattered was how long the seller reasonably needed to decide whether or not to withdraw, rather than how long the buyer reasonably needed to make up for non-performance (i.e. to pay the balance).
In this case, the judge said it was “entirely straightforward” to decide what to do on non-payment, and that, in these circumstances, it was not reasonable to take 13 business days to decide whether or not to terminate the contract.
Not only this, but the court found that the seller had “affirmed” the contract and effectively waived the failure to pay on time. On 1 April 2021, the seller had threatened to terminate if payment was not made but, even though the buyer made no payment, the seller did not terminate. Instead, the seller continued to answer the buyer’s questions and to liaise with the manufacturer to facilitate the sale.
What does this mean for me?
Contractual termination rights are common in a whole host of agreements, such as contracts for the sale of shares or other securities, goods, services, real estate or even an entire business, licences of intellectual property, loans, joint ventures and consortium arrangements, investment, and placing and underwriting arrangements.
The judgment raises certain obvious but important points for a commercial counterparty which has become entitled to terminate an arrangement under a contractual termination right.
- Act swiftly and do not drag your heels. The longer the delay in exercising the right, the more likely the court is to find that it is no longer reasonable to withdraw.
- Be careful of doing anything that could be seen as continuing the contract. The court will normally give a party reasonable time to consider its position, but any positive actions or statements might be taken as treating the contract as ongoing.
- Reserve your position. Although it may not always work, it may help to clarify to the other party that the right to terminate is not being waived and will be exercised if the other party does not fulfil their obligation or remedy their default by a particular deadline.
If contract parties do not want to be restricted to exercising contractual rights of termination within a reasonable time, it will help when drafting the contract to state that the party in question can terminate “at any time” following the relevant termination trigger. But even this is not foolproof.
- It will not stop a court finding that a party has, by its conduct, accepted the event that triggered the termination right (although it may make it more difficult).
- Unless the contract contains a “no oral modification” clause (see our previous Corporate Law Update), it is also open to the court to find that the parties have varied the contract in some way to permit later payment or delayed performance.
- As noted above, even if a party has an unfettered right to terminate, if they indicate that they do not intend to do so, the other party may argue that they elected not to exercise that right.
Covid-19 restrictions did not amount to force majeure
The High Court has held that government restrictions imposed in response to the Covid-19 pandemic did not, in the circumstances, amount to a force majeure under a contract.
NKD Maritime Ltd v Bart Maritime (No. 2) Inc.  EWHC 1615 (Comm) concerned an agreement under which a shipowner agreed to sell an obsolete ship to a recycling yard in India.
The contract contained a force majeure clause, which stated that “should the Seller be unable to transfer title of the Vessel or should the Buyer be unable to accept transfer of the Vessel . . . due to [(among other things)] . . . restraint of governments, . . . then either the Buyer or the Seller may terminate this Agreement . . . without any liability upon either party . . .”
What is a force majeure clause?
Force majeure (or FM) is a contractual mechanism that relieves a party from liability for breach of contract if the breach is caused by an event outside the party’s control. It is designed to recognise that a party should not be penalised where it cannot fulfil the contract due to events it cannot influence.
An FM clause normally suspends a party’s obligations while it tries to rectify the issue. It will also normally allow a party – possibly only the “innocent” party or possibly either party – to end the contract if the FM is not resolved after a specified period of time.
The contract will usually set out what qualifies as an FM. This often includes a rather bleak panoply of events, including natural disasters, epidemics, civil unrest and war. If the contract relates to a specific project, parties might also include more specific events.
Before the ship could be delivered, the Government of India imposed a period of lockdown restrictions in response to the ongoing Covid-19 pandemic.
As a result, the shipowner was unable to deliver the ship at the place for delivery required by the contract. Instead, it delivered the ship outside the area limited by the restrictions in what it regarded as the “customary waiting area” for ships to be delivered to the recycling yard.
That lockdown was later extended. That same day, the recycling yard’s agent sent a notice purporting to terminate the contract on the basis that the lockdown restrictions amounted to a force majeure that had prevented, and would continue to prevent, the shipowner from transferring title to the ship.
The shipowner denied there had been a force majeure. It said that it was not necessary to deliver the ship to the desired location in order to transfer title, and that the purported notice of termination amounted to a breach of contract of such nature that it entitled the shipowner to treat the contact as terminated (a “repudiatory breach”). The shipowner later sold the ship to another buyer.
The circumstances gave rise to various claims, but a key question was whether the imposition of lockdown restrictions amounted to a force majeure.
What did the court say?
The court found that the shipowner had been able to transfer title to the ship to the recycling yard without delivering the ship to the intended location. However, in case that conclusion was wrong, the judge considered whether there had been a force majeure due to the lockdown restrictions.
The judge said that no force majeure had occurred.
The lockdown restrictions had required officials at one of the relevant authorities to work on other matters, delaying the issue of clearances required to deliver the ship to the desired location. However, eventually, as restrictions were eased, authorities began to issue clearances again. The likelihood was that the ship would have been cleared to proceed to the delivery location in relatively short order.
The restrictions had “hindered” or “delayed” delivery of the vessel, but they had not created an “inability” to deliver it and so fulfil the contract. The shipowner would only have become “unable” to deliver the ship if the likelihood of a long period of lockdown restrictions would have materially undermined the parties’ “commercial adventure”. In this case, it had not.
The judge also said that it was not possible to assess this merely by reference to cancellation dates set out in a contract. This would mean that “potentially very short-lived and transient hindrances to performance” might trigger the force majeure clause.
What does this mean for me?
This is an interesting example of the extent to which the courts will regard Covid-19 and the various restrictions and other consequences it has brought as something sufficiently significant to interfere with contractual relationships.
The courts will not allow a party to invoke a force majeure mechanism lightly. If a party can still perform a contract, even if to do so would involve notably greater expense, it will hold them to it. Contract parties should not simply assume that they can use Covid-19 as an excuse or reason to walk away from commitments.
The court’s reference to “materially undermining the commercial adventure” is also interesting. This is traditionally a feature of “frustration”, a separate legal doctrine that automatically discharges a contract where it has become impossible to perform or performance has become fundamentally different. Frustration can apply whether or not the contract contains a force majeure clause, but the threshold is high and the courts are generally even more reluctant to find frustration than a force majeure.
Although we have seen a significant easing of Covid-19 restrictions over recent months, the same principles could well apply should there be a resurgence of the virus, a different pandemic or some other event that brings about widespread restrictions.
The ongoing conflict in Ukraine is a potentially comparable example. Recent sectoral sanctions introduced by the UK and other jurisdictions prohibit various activities involving persons connected with Russia, such as restrictions on dealing with securities issued by, or lending money to, Russian-linked entities or persons controlled by them.
These restrictions may in turn leave contract parties unable to perform some or all of their obligations. Parties will need to study their contractual arrangements carefully and take legal advice to understand the extent to which they are still required to perform their obligations. For more information on sectoral restrictions, see our separate explainer (published on 2 March 2022).
FRC reports on impact of the new Stewardship Code
The Financial Reporting Council (FRC) has published a research study into the impact which the new Stewardship Code is having in practice.
The Code sets out what the FRC considers best practice for institutional asset owners and asset managers when exercising their stewardship responsibilities. Like the FRC’s UK Corporate Governance Code, it operates on a “comply or explain” basis. Certain asset managers are required to report against the Code under the Financial Conduct Authority’s Conduct of Business Sourcebook. Other institutional investors can apply to become “signatories” to the Code and adopt it voluntarily.
The FRC introduced the current version of the Stewardship Code in late 2019, with that version taking effect from 1 January 2020. The current version expands substantially on previous versions of the Code, applying not only to asset owners, but also asset managers (including pension funds) and service providers, and covering all kinds of capital (both publicly traded and privately held).
For more information, see our previous Corporate Law Update.
Key findings from the research study include those set out below.
- Asset managers and owners are positive about the new Code. The FRC found strong evidence of material changes of practice following the introduction of the current version of the Code.
- Respondents reported increases in stewardship resourcing, growth in stewardship teams and an increased use of external experts. Staffing and research budgets are expected to grow.
- All organisations sampled reported some form of restructuring to better integrate stewardship within investment decision-making. Typically, large asset managers had separate environmental, social and governance (ESG) teams that worked more closely with specialist investment teams.
- All respondents undertook some form of engagement with companies. Working with other investors was an increasingly important escalation tool, especially on ESG issues.
- Respondents want more guidance on stewardship in asset classes other than listed equities, with the Code accelerating the introduction of stewardship practices in other asset classes.
- The Code had been a useful framework, giving stewardship teams more influence on investment decisions. The new emphasis on reporting the activities and outcomes of stewardship has prompted a major change in behaviour, encouraging investors to be more reflective.
- Asset owners are now looking beyond policies and increasingly require their managers to robustly demonstrate their stewardship activities and achievements.
FCA consults on changes to improve equity secondary markets
The Financial Conduct Authority (FCA) is consulting on rule changes designed to improve secondary trading in equities in the UK. The purpose of the changes is to enhance the quality of execution for investors and improve the information content of post-trade transparency.
Key proposes set out in Consultation Paper CP22/12 include those set out below.
- Improving the content of post-trade transparency by enabling market participants to better identify transactions that contribute to the price discovery process and to improve the consolidation of trade reports from multiple sources.
- Simplifying over-the-counter (OTC) transaction reporting for all classes of financial instrument.
- Improving choice and competition by allowing UK trading venues to use reference prices from overseas venues, where those prices are robust, reliable and transparent.
- Improving the quality of execution by removing restrictions preventing trading venues from using the same “tick size” (i.e. the minimum increment between quoted prices in a financial instrument) used by trading venues established overseas where the overseas venues are the primary markets in a financial instrument.
- Enhancing market resilience by consulting on what future guidance should cover in relation to the operation of markets before and during an outage.
The FCA is also seeking views on whether improvements can be made to the way retail orders for shares are executed in the UK.
The deadline for responding to the consultation is 16 September 2022.