Guidance on interpretation of contractual audit clause
In a case involving Paddington bear merchandise (Pixdene Limited v Paddington and Company Limited  EWHC 2765 (IPEC)), the High Court has provided some useful guidance on the interpretation of a contractual audit clause under which one party was given the right to inspect documentation belonging to the other.
In March 2013 Paddington and Company Limited (Paddington) entered into a royalty distribution agreement with Pixdene Limited (Pixdene) under which Pixdene was entitled to a 10% share of the net worldwide merchandising income from Paddington Bear.
The agreement contained the following audit clause:
“During the term of this Agreement a third party auditor may, upon prior written notice to Paddington and not more than once per every two year period, inspect the agreements and any other business records of Paddington with respect to the relevant records or associated matters during normal working hours to verify Paddington’s compliance with this Agreement.”
Pixdene exercised its rights under the audit clause in 2014 and again in 2017 with no issues. But when it did so again in 2019 the parties disagreed about the extent of the rights granted under the clause.
Due to the breakdown in the relationship between the two parties (which Pixdene’s counsel put as follows: “the milk of human kindness has long since evaporated between them”) the court was asked to provide as much guidance as possible on what the audit clause did, and did not, oblige or entitle them to do. It was asked to leave nothing to the parties to sort out between themselves using their common sense as they did not believe they would be able to do so.
In relation to the parties’ rights and obligations under the audit clause, the court found as follows:
- Pixdene was entitled to choose a third-party auditor to carry out each audit who must be an independent entity, distinct from either party with no commercial interest in the outcome of the audit.
- Pixdene must give Paddington a reasonable amount of notice (not less than 10 business days) before the proposed audit and must also identify the relevant period for the audit.
- Whilst an audit may cover a period of more than two years, there cannot be more than one audit in each two-year period and an audit cannot cover a period that has already been the subject of an audit.
- The audit must take place at a location chosen by Paddington (acting reasonably) within its control and during normal working hours.
- Paddington must make such copies of the inspected documents as the auditor reasonably required (or allow the auditor to do so) provided that the costs of doing so were met by Pixdene and the auditor agreed to keep the copies confidential.
- Pixdene was not entitled to inspect the documents itself or to receive copies of them.
- The auditor could only disclose information gained from the audit to Pixdene in order to report on certain specified matters (such as the conclusion of the audit and details of any amounts due from Paddington) and had to keep all other information confidential.
- Paddington could only redact documents to the extent they are legally privileged.
Many types of commercial agreement contain some form of audit clause and the one in this case, whilst fairly brief, was not unusual. The question before the court was essentially one of contractual interpretation. Although the meaning of a clause in a particular contract will always turn on the specific words used and the facts of each case, this decision is still useful in providing some guidance on what will (and won’t) be covered by an audit clause. Any rights in excess of those identified by the court (for example a right for the contracting party, not just its auditor, to inspect the relevant documents) will need to be expressly stated in the relevant agreement.
ECJ blow to corporate transparency
The European Court of Justice has ruled that requirements in the Money Laundering Directive for Member States to make publicly available information about the beneficial ownership of corporate entities were invalid as they breached certain provisions of the EU’s Charter of Fundamental Rights (the Charter).
The case (WM and another v Luxembourg Business Registers C-37/20 - ECLI-EU-C-2022-912) involved laws introduced in Luxembourg which established a Register of Beneficial Ownership and provided for various pieces of information about the beneficial owners of Luxembourg-registered companies to be entered in that Register. The Register is essentially the Luxembourg-equivalent of the UK’s Register of Persons with Significant Control – the PSC Register. Some of the information in the Register of Beneficial Ownership was publicly available via the internet.
A Luxembourg company and its beneficial owner asked the administrator of the Register to restrict access to their information in the Register. The administrator refused so the matter was taken to the Luxembourg courts. The courts found that the disclosure of the information in the Register could involve a disproportionate risk of interference with the beneficial owner’s fundamental rights under the Charter. So it asked the ECJ for guidance on the validity of the provisions in the Money Laundering Directive.
The ECJ ruled that the general public’s access to beneficial ownership information interfered with the fundamental rights to respect for private life and the protection of personal data set out in the Charter. So the requirement in the Money Laundering Directive to make beneficial ownership information publicly available was invalid.
The ECJ did find that the provisions in the Money Laundering Directive pursued an objective of general interest – preventing money laundering and terrorist financing – which could justify an interference with the Charter’s rights. However, that must be limited to what was strictly necessary and must be proportionate to the objective pursued. That was not the case here given the detail of the information required to be disclosed in the Register and the degree to which that information was publicly available and capable of further dissemination.
In light of the ruling the European Commission has said it is considering its next steps. Meanwhile some EU Member States, including Luxembourg and the Netherlands, have closed their beneficial ownership registers to public access.
Post-Brexit, decisions of the ECJ are not binding on the English courts although they could be persuasive when interpreting retained EU law. Nor is the UK bound by the Charter, although the Human Rights Act 1998 does include a right to respect for a private life so there is a clear overlap. It remains to be seen whether the UK will change its own laws on the disclosure of beneficial ownership or indeed whether a beneficial owner will now seek to challenge those laws in the UK courts.
Interim dividend not due and payable until paid
In Gould v HMRC  UKFTT 00431, the First Tier Tribunal held that an interim dividend paid to two shareholders on different dates was not due and payable, and therefore was not taxable, until the respective dates of payment. This resulted in the dividend being taxed in different tax years for each shareholder.
Interim and final dividends
A dividend is subject to income tax in the hands of an individual shareholder when it becomes “due and payable”, and there is a distinction in this regard between final dividends and interim dividends. Once a dividend has become due and payable – i.e. a debt – the directors cannot revoke it and the shareholder becomes entitled to enforce payment.
Final dividends are paid once a year (traditionally at the end of a company’s financial year) and are typically declared by shareholders following a recommendation from the board of directors. A final dividend will become a debt payable to shareholders at the time specified for payment in the shareholder resolution declaring the dividend. If, however, the resolution does not specify a time for payment, the final dividend will become due and payable immediately.
In contrast, interim dividends can be paid at any time throughout the year and are typically decided solely by the board. Unless declared by shareholders, an interim dividend becomes a debt payable to shareholders when it is paid, rather than when the board resolves to pay it. There is no legal liability to pay interim dividends, even when they have been properly approved by the directors, as the board can always rescind its resolution to pay an interim dividend at any time up to actual payment.
The board of a company resolved to pay an interim dividend of £40m to its two shareholders on 31 March 2016. £20m was paid to one shareholder (S1) on 5 April 2016 (the last day of the 2015/16 tax year) and £20m was paid to the other shareholder (S2) on 16 December 2016.
S2 had elected to delay receipt of his dividend payment, partly due to the administrative difficulties of opening a bank account in Jamaica, but also to be able to claim non-resident status for UK tax purposes for the tax year 2016/17.
HMRC brought proceedings to claim unpaid tax on S2’s £20m dividend on the basis that it should have been taxed in the UK for the tax year 2015/16. HMRC argued that the dividend paid to S2 became an enforceable debt as soon as S1 received his dividend payment in April 2016 (i.e. during the 2015/16 tax year). This was because the company’s constitution, and English common law, both required the company to pay dividends equally and proportionately across shares of the same class.
The Tribunal disagreed with HMRC and held that S2’s dividend was not due and payable until it was actually paid to S2 on 16 December 2016.
When reaching its decision, the Tribunal rejected HMRC’s argument that S2 could enforce the dividend from 5 April 2016 – the date that S1 had received payment. Although the company was required to treat both shareholders equally, there was nothing in the company’s constitution to suggest that a debt arose if an interim dividend was paid to different shareholders of the same class at different times.
The Tribunal acknowledged that S2 could potentially have claimed unfair prejudice for the company’s failure to pay the interim dividend to all shareholders at the same time. However, any such claim was unlikely to be successful as S2 had agreed (under professional advice) to the deferral of his payment. It could also not be assumed that a court would order monetary compensation (such as payment of the dividend) on a successful unfair prejudice petition. Any remedy would be at the court’s discretion, and it could not be said with any certainty that the court would have ordered the payment of the dividend nor that it would have found the dividend to have been due and payable on 05 April 2016.
The Tribunal’s decision is useful confirmation that an interim dividend does not become a debt (and, therefore, taxable) until it is paid. This principle allows companies to pay an interim dividend to one group of shareholders at different times with a view to maximising shareholder tax planning.
Shareholders should be aware, however, that this flexibility does leave them exposed to the risk of non-payment. If a shareholder chooses to defer receipt of an interim dividend and the company’s financial position deteriorates in the intervening period, the directors may be obliged to cancel the payment in compliance with their duties to the company.
First published in Accountancy Daily.