Finance Update August 2003

in this issue
Financial Assistance MT Realisations Ltd (in liquidation) v Digital Equipment Co Ltd [2003] EWCA Civ 494

M A Y E R BROWN R O W E & M A W

Financial Assistance
MT Realisations Ltd (in liquidation) v Digital Equipment Co Ltd [2003] EWCA Civ 494
The Law Under s151(1) Companies Act 1985, where a person is acquiring shares in a company, it is unlawful for that company or any of its subsidiaries to give financial assistance for the purpose of that acquisition before or at the time of the acquisition. In addition, under s151(2) of the Act, where any liability has been incurred for the purposes of that share acquisition, no financial assistance may be given directly or indirectly to reduce or discharge that liability. Financial assistance includes the giving of a guarantee or other security or the making of a loan, or any other financial assistance given by a company the net assets of which are thereby reduced to a material extent or which has no net assets. Here, net assets means the aggregate of the companys assets minus the aggregate of its liabilities. The Case The case of MT Realisations Ltd (in liquidation) v Digital Equipment Co Ltd has once again reinforced the basic message that each situation should be judged on its own facts to determine whether unlawful financial assistance has been given. It is an indication of the complexity of this area that, while the Court of First Instance and the Court of Appeal both ruled that there had been no financial assistance, they gave different reasons for reaching their conclusion. In brief, the case concerned an allegation by the liquidator of MT Realisations Ltd (the Target) that the setting off of debts owed to the Target by the Seller against liabilities which had originally been incurred by the Purchaser at the time of the share acquisition (albeit incurred in relation to an assignment of loans to the Purchaser (such loans having originally been entered into between the Seller and the Target)) was unlawful financial assistance since it reduced a liability incurred for the purposes of the share acquisition. At both levels, the Court held that the setting off of the debts owed to the Target against the liabilities of the Purchaser to the Seller did not constitute financial assistance. In the Court of First Instance, the judge held that, while the loan assignment and share acquisition were entered into as part of the same deal (and the loan assignment had even acted as an inducement to the share acquisition, which would probably not have taken place without such inducement) the two were separate transactions and, consequentially, a restructuring of the payments under the loan assignment could not affect or reduce the liability incurred under the share acquisition. In the Court of Appeal, a different reason was given; namely that the

VAT on Outsourcing of Bank Services Customs & Excise Commissioners v Electronic Data Systems Ltd

Consumer Credit Proposals to tackle extortionate credit agreements

Conditions to the Release of a Guarantee Singer & Friedlander Commercial Finance Limited v Thomas

Key Differences Between the U.S. Bankruptcy Code and the U.K. Insolvency Act 1986

Enterprising times ahead Enterprise Act 2002

Purchaser was entitled (under the assigned (and secured) loans) to require the Target to call in the amounts owed to it by the Seller and was free to use those amounts to pay off the Seller. The restructuring of the payments under the loan assignment was merely short circuiting the route that would be taken by the payments in any event (by setting off the debts directly) and the Purchaser was not getting anything from the Target that it was not already entitled to under existing arrangements. At the end of the day, it is difficult to draw out any hard and fast principles as to what may or may not constitute unlawful financial assistance in the future - each case will continue to

be dealt with on its own particular facts. It looks as if good legal advice when embarking on a share acquisition (or any dealings with financial obligations which are (or may be seen to be) connected with such a share acquisition) will remain crucial to ensure that the fairly draconian penalties attached to unlawful financial assistance are not incurred. A fuller version of this note appears at [www.mayerbrown rowe.com/London/groups/finance/news.asp] for further information or advice please email Nigel Wright (nwright@mayerbrownrowe.com) or Simon Pullen (spullen@mayerbrownrowe.com) or your usual contact.

VAT on Outsourcing of Bank Services

Customs & Excise Commissioners v Electronic Data Systems Ltd
The Court of Appeal has held that the supply of outsourced services for the making and granting of loans to a banks customers is a VAT exempt supply under Article 13B(d)3 of the Sixth Council Directive. Article 13 contains a number of VAT exemptions; it has direct effect and has also been implemented by national legislation. Banks predominantly make supplies of exempt financial services with the result that they are not able to recover input tax to any significant extent. Accordingly, where VAT is charged to a bank this will represent a real increased cost. The result of the decision is that VAT does not have to be charged in respect of outsourced services of the type under consideration and this will reduce the costs to the bank of making supplies to its customers. In this case Electronic Data Systems Ltd (EDS) operated a loan centre from which it supplied administrative services to Lloyds TSB. EDS was the contact point between the bank and actual and potential customers and its main functions were to receive initial applications for loans and to record details of the applicants; to validate the applications; where a loan had been validated to produce and forward to the borrower a loan agreement signed on behalf of the bank, to release funds and to collect payments. Lloyds TSB continued to be responsible for matters such as setting credit policy, dealing with delinquent loans and sales and marketing. EDS was paid variable charges by Lloyds TSB relating to the specific functions and the amount paid depended upon the volume of commercial activity. The dispute between EDS and HM Customs & Excise was initially heard by the VAT Tribunal where EDS was successful. Customs then appealed direct to the Court of Appeal under the fast track procedure. The Court of Appeal determined that the package of services supplied by EDS could be described as loan arrangement and execution services and that the main supply within that package was the provision of administrative services in connection with the making of loans with the result that they were exempt under Art 13B(d)3. Whilst each case will undoubtedly have to be looked at on its particular facts the decision provides useful guidance as to the VAT treatment to be adopted in relation to outsourcing arrangements of this nature. For further information please contact Trefor John (tjohn@mayerbrownrowe.com) or your usual contact at the firm. Since this article was written HM Customs & Excise have issued Business Brief 11/2003. In this they state that they will be petitioning the House of Lords to review the Court of Appeal decision. They also set out details of the practical implications of what should be done until the position is finally resolved.

Consumer Credit
Proposals to tackle extortionate credit agreements
Government plans to make it easier to challenge extortionate credit agreements published on 6 March 2003 have been welcomed by the Office of Fair Trading. The provisions of the Consumer Credit Act 1974 which allow individuals to challenge an extortionate credit agreement in court have been viewed as ineffective by the OFT for a number of years. The courts have construed the provisions strictly and in a limited way and because of the complexity and associated uncertainty and expense of litigation, the legislation has been not effectively protected consumers. In 1991 the OFT published a report on Unjust Credit Transactions and since then it has pushed for reform. The OFT Executive Director, Penny Boyd, believes it is a particularly significant problem because: Extortionate credit operates on the margins of the market where vulnerable consumers are susceptible to exploitation. The main aim of the Governments proposals are to increase the protection available to vulnerable consumers against extortionate credit agreements, reforming the licensing system and providing more accessible means of redress through either the courts or through alternative dispute resolution mechanisms. Specific proposals welcomed by the OFT include: replacing the current grossly exorbitant test by one encompassing the less stringent concept of excessive payments; allowing the courts to consider matters arising after the agreement was entered into, including interest rate variations; including as one of the factors to be taken into account by the courts whether the transaction involved business activity which was deceitful or oppressive or otherwise unfair or improper in line with the Consumer Credit Licensing Fitness Test; encouraging greater use of time orders where the courts consider that the borrower should be allowed more time to repay, or that the length of the loan or the interest rate needs to be changed; requiring the courts to notify the OFT of extortionate credit cases, so that the OFT can provide a public record and issue guidance; giving the OFT and other qualified entities the power to seek a declaration that a particular credit transaction is unjust in its effect on consumers; giving the OFT the power to make restitution orders as a means of compensating consumers affected by extortionate credit deals; imposing an obligation on lenders to lend responsibly and with proper regard to the borrowers ability to repay; and extending the jurisdiction of the Financial Services Ombudsman to all consumer credit, as part of a range of mechanisms to enable consumers to complain about unfair terms and practices and seek redress.

In addition to these proposals the OFT also argues that the court should be able to reopen an agreement of its own motion. This would be a valuable additional protection for consumers who are unrepresented in court action. The Government consultation document Tackling loan sharks and more! is available through the DTI website (dti.gov.uk). If you would like further information on the potential impact of the Governments proposals please contact Stephen Walsh, (swalsh@mayerbrownrowe.com) or your usual contact at the firm.

Conditions to the Release of a Guarantee

Singer & Friedlander Commercial Finance Limited v Thomas
The question arose in the case of Singer & Friedlander Commercial Finance Limited v Thomas [2003] EWHC 861 of what is meant by the putting in place of a chattel mortgage. The facts were as follows. Mr Thomas, the Chairman of British Creameries Limited agreed to give a personal guarantee in order to secure the supply by Singer & Friedlander of machinery on hire purchase to British Creameries. The personal guarantee was to be a temporary measure to be effective only until the time a chattel mortgage was put in place. The mortgage was to be the main security for the agreement. It was agreed between Singer & Friedlander and Mr. Thomas that the personal guarantee would be released as soon as the chattel mortgage was put in place. The chattel mortgage was registered at Companies House on 16 October 2000 before certain deeds of release and priority were obtained with respect to earlier charges granted over British Creameries property; it was necessary under the terms of certain existing charges for other chargeholders to agree the release/subordination of their charges. The issue was, did the registration amount to the chattel mortgage being put in place (notwithstanding it did not have the priority expected by Singer & Friedlander), thereby releasing Mr. Thomas from his guarantee? British Creameries was placed into administrative receivership by Lloyds TSB on 22 November 2000 and Singer & Friedlander sought, from Mr. Thomas, 156,517 plus interest under his guarantee in respect of the machinery which was financed, alleging that the mortgage had not been put in place. It was held that the registration of the chattel mortgage meant that it had been put in place. There had previously been no judicial decisions on the meaning of this phrase so it was interpreted in line with its meaning in the Oxford English Dictionary: in the original or proper position, suitable or appropriate position. The mortgage was in such a position when it was registered this was its intended position. The registration of the chattel mortgage meant that it ranked ahead of subsequent charges and unregistered debts. It would be unjust if Singer & Friedlander were to have the benefit of the personal guarantee and the registered chattel mortgage. HH Judge Anthony Thompson was further influenced by his belief that Mr. Thomas would not have given the undertaking had he known at the time of entering into it that Singer & Friedlanders solicitors would argue that the mortgage would not be classed as being complete until the deed of release and deeds of priority had been executed. Although an inexperienced, and somewhat unreliable, lawyer acting for Singer & Friedlander and the commercial pressures on Mr. Thomas, an individual, to enter into the guarantee might have slightly swayed the judge, the decision appears sound. However, the lesson clearly to be learnt is that if parties to a security document have agreed that it should cease to be effective or be released on a certain date or on the occurrence of a certain event then the document should stipulate very clearly the terms of that agreement.

Key Differences Between the U.S. Bankruptcy Code and the U.K. Insolvency Act 1986
We have prepared a brief summary highlighting some of the key differences between corporate insolvency under the U.S. Bankruptcy Code (the Code) and the English equivalent, the Insolvency Act 1986 (as amended the IA), focussing primarily on issues relating to procedure, the position of creditors vis-a-vis the debtor company and certain policy considerations. This is especially apposite since the Enterprise Act 2002 has amended IA to promote a rescue culture and collective insolvency procedures at the expense of certain creditor friendly procedures. The text of this summary can be found at www.mayer brownrowe.com/london/groups/finance/news.asp. For further information please contact Simon Pullen (spullen@mayerbrownrowe.com), Ian Coles (Icoles@ mayerbrownrowe.com), any member of the Restructuring and Insolvency Team or your usual contact here.

Enterprising times ahead

New legislation is due to come into force in September this year that will make some important changes to the law of corporate insolvency. The Enterprise Act 2002 as a whole is designed to promote fair competition, with the corporate insolvency provisions focusing, in particular, on more effective means of rescuing poorly performing businesses. This article discusses the Acts principal provisions relating to corporate insolvency. The main changes are: the abolition of administrative receivership (except in limited circumstances); the introduction of a new streamlined administration procedure; the introduction of measures to benefit unsecured creditors. prevents creditors from pursuing their legal remedies against the company. This will give the company some breathing space to sort out its difficulties. Once the relevant parts of the Act are brought into force, a court hearing will no longer be required in the majority of cases. Provided that the relevant conditions are satisfied, an administrator can be appointed out of court on the filing of the prescribed documents at court. The Act allows the appointment of an administrator out of court by: the holder of a qualifying floating charge (defined in the Act); the company or its directors.

(The text of the Act can be downloaded from www.hmso.gov.uk/acts/acts2002/20020040.htm.) Abolition of administrative Receivership

As is currently the case, an administrator may also be appointed by court order on the application of the company, its directors or one or more creditors of the company. The Act also alters the purposes of administration. There is now a hierarchy of objectives, according to which the administrator must perform his functions. The objectives are: 1) rescuing the company as a going concern; or

Administrative receivership involves the enforcement of a floating charge holders security, without the need for an application to court. In practice, salvaging viable parts of the struggling business may not be top of the administrative receivers list of priorities, since he owes his primary duty to the charge holder that appointed him and his priority will be to realise assets to satisfy the charge holders debt. Although it is often the case that a going concern sale is the best way to maximise the return to the floating charge holder, the Act seeks to alter the priorities, so that rescue becomes an objective rather than simply an occasional happy coincidence. Under the Act, administrative receivership is abolished, except in relation to certain capital market and other transactions (public-private partnership projects, utility projects, financed projects and financial market contracts). However, floating charge holders will still be able to appoint administrative receivers under floating charges created before the Act comes into force. New administration procedure Administration is, by contrast, a collective procedure designed, above all, for cases where the whole or part of a business may be rescued. An administrator is appointed by the court, as the law currently stands, and he owes duties to all the companys creditors. An important benefit of the procedure is the imposition of an automatic moratorium that

2) if (1) is not reasonably practicable, achieving a better result for the companys creditors as a whole than would be likely if the company were wound up; or 3) if neither of the objectives above is reasonably practicable, and the interests of creditors of the company as a whole are not unnecessarily harmed, realising property in order to make a distribution to one or more secured or preferential creditors. More stringent time periods now apply to the conduct of an administration. The initial creditors meeting must be held within 10 weeks and the administration will automatically end after one year, subject to an extension being ordered by the court or agreed to by a specified proportion of creditors. Measures benefiting unsecured creditors Abolition of Crown preference The current position is that many debts due to the Crown (including debts due to the Inland Revenue, Customs & Excise and social security contributions) take priority over debts owing to floating charge holders and unsecured creditors. However, the Act will abolish the Crowns status as a preferential creditor. The good news for employees is

that their claims, together with their employers contributions to occupational pension schemes, will retain their preferred status. Creation of a ring-fenced fund There is also good news for the companys unsecured creditors. Where there is a floating charge over property of a company, unsecured creditors will, in future, have a prescribed part of the companys property made available to them for the satisfaction of their debts. The provisions will apply to all types of insolvency regime, including liquidation. The creation of a ring-fenced fund in this way may counterbalance any benefit that floating charge holders derive from the abolition of Crown preference.

Conclusion The corporate insolvency provisions of the Act will promote the use of administration as a means of rescuing failing companies. However, the phasing out of administrative receivership is likely to be a slow process, given that floating charge holders will retain the right to appoint administrative receivers under floating charges created before the Act comes into force. Whether the provisions will have the intended effect of rescuing a greater number of companies from the brink of insolvency remains to be seen. Sally Baker is a solicitor in the Restructuring and Insolvency Group of Mayer, Brown, Rowe & Maw LLP

Notes

This update contains a brief summary only of recent legal developments. For further details and/or advice on a particular article please contact the lawyer(s) named below it. 11 Pilgrim Street, London EC4V 6RW, Tel: +44 (0)20 7248 4282, Fax: +44 (0)20 7782 8774 Website: www.mayerbrownrowe.com/london Mayer, Brown, Rowe & Maw LLP, 2003. Mayer, Brown, Rowe & Maw is a combination of two limited liability partnerships, each named Mayer, Brown, Rowe & Maw LLP, one incorporated in England and one established in Illinois, USA. If you would prefer not to receive future publications or mailings from Mayer, Brown, Rowe & Maw LLP, or if your details are incorrect, please contact us by post or by email to businessdevelopment@mayerbrownrowe.com.

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