Talking Business podcast: how will Government exercise its new powers to intervene in transactions?

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In this month’s round up of recent developments, host Sophie Brookes explains the digital process for stamping documents, such as stock transfer forms, and also examines the latest guidance about how the Government will exercise its new powers to intervene in transactions on the grounds of national security. She also tells a cautionary tale of a case in which a director was held personally liable for auction bids he placed on behalf of his company and explains the limits placed on a party exercising a contractual discretion.

In this episode:

  • We explain the new digital process for stamping documents.
  • We review the latest guidance on the government’s new powers to intervene in transactions on grounds of national security.
  • We tell a cautionary tale of a director found personally liable for auction bids.

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This episode is part of our Talking Business podcast series. Learn more about the series and what we cover. This podcast is available on SpotifyApple Podcasts and Google Podcasts.

Read the transcript:

Sophie Brookes: Welcome to Talking Business, your straight talking guide to dealing with corporate matters, whether you are a private or public company, an owner managed business, or an entrepreneur, a director, company secretary, or in-house counsel, this is the podcast for you. My name is Sophie Brookes and I'm a partner in our corporate team. I was a transactional lawyer for a number of years before becoming a professional support lawyer, which means I'm now responsible for know how across our corporate team. Each month, I'll provide an update on the latest developments that matter to you. And we'll be joined by an expert to take a deep dive into a key corporate law topic.

Okay, so first off this month, I thought I would just mention the new digital process for stamping documents. So back in April, 2020, when we were all scrambling to organize new processes to accommodate homeworking, HMRC introduced a temporary digital process for stamping documents. And particularly I'm talking about stock transfer forms here. So they've now confirmed that this process has been made permanent, which brings to an end the 300 year old process of stamping documents manually via the stamping presses. So now original stock transfer forms have to be submitted to HMRC by email, still within 30 days of being signed and dated. But at the same time, as submitting the documents by email, the appropriate duty must also be paid to HMRC. So they're not going to process a document for stamping unless the relevant duty has been received. The rate of duty stays the same. It's stil  0.5% of the consideration, rounded up to the nearest £5.

And one thing to watch out for is that because payment of the duty is separate to emailing the form, you need to be extra careful to ensure that the reference attributed to the payment, when you pay that via Bacs or bank transfer is the same as that attributed to the documents when you send those in by email, so that HMRC can match up the relevant duty payment that they receive to the relevant document. So following stamping, HMRC will send a letter containing a verification code and it's that letter and code, which acts as the digital stamp in place of the old physical stamp. So HMRC's letter confirms receipt of the stamp duty, it details the transactions it's confirming receipt for, and the verification code and it helpfully confirms that the stock transfer form or other instrument of transfer has been duly stamped so that the registrar can register the new ownership of the shares. So once you received that kind of a letter, the letter and the stock transfer form can then be submitted to the company secretary or the registrar for registration in the company's books.

Going forward, the letter should probably then be kept with the stock transfer form in order to evidence that duty has been paid on that form and actually annotating the form with the relevant verification code is probably a good idea. It helps provide protection if the letter and the form are ever later separated, just so that you can evidence that the duty has been paid on the form.

So as well as stock transfer forms, that digital stamping process applies equally to the company's house form SHO3 which records the purchase of own shares, and Companies House have also updated their guidance to confirm that that letter that you get back from HMRC confirming that duty has been paid, has to be submitted with the form SH03 when you send that to company's house for filing.

Really helpfully also, HMRC have confirmed that where a document has been stamped digitally since March, 2020, when the digital process was first introduced as a temporary process, there is no need to resubmit it for stamping under the new permanent procedure. So that wasn't clear previously, and lots of people have been kind of hanging on to those stock transfer forms, wondering if they were going to be required to resubmit them, to get a physical stamp on them. But like I say, HMRC have confirmed that no, that isn't the case.

And then in another kind of welcome change to the previous process, HMRC have also confirmed that they will now accept electronic signatures on documents for stamping. And again, I think that just reflects the way that processes for signing documents have changed and evolved over the last 18 months with increasingly documents being signed electronically and HMRC are confirming there that like everybody, whilst they might've been reticent about them to begin with, they've now got comfortable with that process and they will accept those electronic signatures.

So next up, there've been some more developments to do with the National Security and Investment Act. So we featured this in a previous episode of the podcast explaining these new powers that the government has, or is going to have, to intervene in transactions on the grounds of national security. So the act, the National Security and Investment Act received royal assent back in April, but it isn't actually enforced yet. One of the reasons for that is because we've been waiting for various pieces of secondary legislation, so different regulations that are required to give effect to the act's provisions. So the government has now produced a first draft of it, a key set of the regulations under that act together with a statement on how the government is going to exercise its powers under the act, and also some additional guidance for businesses which is useful.

So as a quick recap of the new regime, there are basically three key elements to the regime under the act. So first off, we've got a mandatory notification regime for some transactions in certain specified sectors. Then we've got a voluntary notification regime for certain transactions outside those sectors, but which may still give rise to a risk to national security. And then finally, the third element is the government's call-in empowers under which they can review transactions, which should or could have been notified under either the mandatory or the voluntary regime.

So the new set of regulations, which I mentioned, have a ridiculously long title. They're called The National Security and Investment Act 2021 Notifiable Acquisition, Specification of Qualifying Entities Regulations 2021. A bit of a mouthful. Anyway, they're a key sets of regulations because what they do is set out the definitions of those 17 specified sectors in which the mandatory notification regime is going to operate. So a qualifying transaction in one of those sectors will not be able to complete until clearance has been received from the new investment security unit within base. Any notifiable transaction that completes without getting that clearance crucially will be void. So it's really important to understand those sectors, to understand how they apply and if your transaction falls within them, then make sure that you apply for that clearance. So you make that mandatory notification and you don't complete until you have received clearance to do so.

So the sector definitions, they'd previously been set out in a consultation paper, and since then, the government's further refine them after what it called targeted engagement with stakeholders. And as a result of that, we've got these final definitions included in these new regulations. Now the majority of them, if you've been following the progress of this act, the majority of them really are substantially in the same form as they were in that original consultation, but some of them have been redrafted. So for instance, the section on energy, energy is one of the specified sectors. That one has been redrafted and expanded. So if that's a sector that could be relevant for you, then do you take a look at the updated definition. Similarly suppliers to the emergency services, another sector that's been expanded so it no longer relates simply to critical suppliers to the emergency services. That word's been dropped. And then another sector communications, that's been reworded so that it targets public communications, networks and services as well as providers of submarine cable systems. So that's in relation to the regulation specifying the sectors.

The other thing that the government has issued is a statement on how it's going to exercise its call-in power. So remember, that's the third element of the regime that I mentioned. We've got the mandatory notifications, we've got the voluntary notifications, and then we've got these call-in powers under which the government can call in a transaction for review. So what the government has done here in the statement is try to explain or give a bit of clarity about how and when they are likely to exercise those call-in powers. And what they've said is that transactions in the 17 specified sectors, perhaps unsurprisingly, are more likely to be called in for a review because they're considered to be the areas in which risks to national security could be more likely to arise.

And similarly transactions in areas of the economy, which are closely linked to those sectors, but which are outside the mandatory notification regime are also more likely to be of interest. So for example, if you've got a transaction which relates to data infrastructure, which is one of the specified sectors, but you don't strictly fall within that definition of data infrastructure, then that's still potentially a transaction, which the government might be interested in. So helpfully, the statement confirms that transactions, which are outside the specified sectors are "unlikely" to be called in because national security risks are expected to occur less frequently in those areas.

So also in this statement, the government's given a bit more information about the factors that it's going to take into account when it decides whether or not to exercise it's call-in powers. So these are confirmed as being ... There are three of them. So the first one is the target risk. So that's whether the target is being, or could be used in a way that poses a risk to national security. Then there's the acquirer risk. So that's whether the acquirer has characteristics that suggest there is, or may be a risk to national security from it having control of the relevant target of the transaction. And in particular, acquirers that have some connection to a foreign government or foreign entity are perhaps going to be more likely to trigger that particular risk. And then there's the control risk. So that's whether the amount of control that the acquirer will gain from the transaction poses a risk to national security.

So if one or more of those three risk factors arise, then again, the transaction is more likely to be called in for a review. But again, the government has confirmed that for most transactions, it anticipates at the overall consideration of these risks is expected to indicate that there's a low risk to national security and therefore a low risk of that transaction being called in.

So the other thing that you might find helpful is that the government has published a guidance note for businesses aimed at helping them prepare for the new regime, which it's worth having a look at. I think the reassurance is from the government, that it expects to use its powers to intervene in transactions sparingly will be welcomed, but I think until the regime is fully enforced and parties can see how it operates in practice, it still seems likely that we're going to see an increase in precautionary, voluntary notifications in order to avoid the more drastic consequences of failing to notify when required. As I say, if your transaction is caught by the mandatory notification regime and you make a decision not to notify because having looked at the sector definition, perhaps you think it falls outside that transaction. Well, if the government decides that actually it falls within that definition and you don't notify, then your transaction will be void.

Helpfully, we've also now got an implementation date for the new regime. So the government has said, it's going to come into force on the 4th of January, 2022. But remember there is a slightly controversial element to the act because transactions entered into before that date can be called in for review once the new regime comes into force on the 4th of January. So this is a sort of retrospective element to this legislation and it applies to transactions entered into after the 20th of November, 2020, and before the 4th of January, 2022. So any transaction entered into within that period could be called in for review for a period after the regime comes into force in January.

So at the moment, what you're able to do is go to the Investment Security Unit and get informal guidance on a transaction that you're doing now in order to assess the likely risk of it being called in. So that is just informal guidance and it is non-binding. And therefore in theory, the Investment Security Unit could decide post 4th of January to investigate one of those transactions, but on the whole that's pretty unlikely. But I think if you are doing a transaction between now and the 4th of January, particularly 1 within the 17 specified sectors, then you should definitely be going to the Investment Security Unit to get their take on it. Okay.

Finally, I thought I would mention a couple of different cases that I thought you might find interesting this month. So the first one, rather alarmingly is a case where a company director ended up being personally liable for auction bids that he'd made whilst he thought he was acting on behalf of the company. So the case is called Tattersalls versus McMahon, and it relates to a company that was set up to deal in bloodstock assets. So broodmares, yearlings and foals, horses, racehorses. Two individuals were appointed as the company directors and in order to attract investment into the company, they applied for advanced assurance under the EIS Scheme. To ensure that they were able to bid at Tattersall Limited's upcoming sales, one of the directors completed their new buyer form, listing the company as the relevant new buyer. And she also applied for, and was granted credit of £300,000.

Now the EIS advanced assurance hadn't been received and therefore no investment in the company had been secured. But the other director, Mr. McMahon attended an auction and successfully bid for 2 foals at a total cost of just over £320,000. When he completed the related purchase confirmations, he inserted the company's name and the auction house subsequently issued its invoices in the name of the company. Now, in fact, the EIS advanced assurance that I mentioned was never received. So the company failed to attract any investors funds and it couldn't pay the purchase price for the two foals. When the auction house subsequently took steps to recover the purchase price, it relied on a provision in its conditions of sale to pursue the director, Mr. McMahon personally. So the key provision in those conditions of sales stated that, "Unless there is in force, a purchaser's authorization accepted in writing by Tattersalls, the highest bidder in the ring, and any principal for whom he may be acting shall be jointly and severally liable under the contract of sale."

Now, Mr. McMahon argued that the purchases were actually made solely on behalf of the company, that he was acting in his capacity as a director of the company when he was making the bids. And therefore the company was in fact, the "highest bidder" in the ring. No purchaser's authorization had been lodged by the company. And so it said no agent had been appointed. So Mr. McMahon said, it must have been the company who bid for and purchased the foals, albeit that it was acting through its director, Mr. McMahon.

Well, unfortunately the judge disagreed with Mr. McMahon. And the judge said that if a bidder, as agent for a principal wanted to avoid personal liability for his bid made in the ring, then he needed to complete a purchaser's authorization. And in the absence of that authorization, then the highest bidder in the ring is personally liable for the purchase together with the principal outside the ring for whom he was acting.

So according to the judge, the words, in the ring, in the conditions of sale emphasized that it's the individual who physically bids for the lots in the ring, that is personally liable for the bid. The judge completely accepted that Mr. McMahon had been acting as agent for the company when bidding for the two lots, but said that that didn't prevent him from being personally liable under the conditions of sale with the company as principal for the auction lots. It was Mr.McMahon who'd been in the ring, and in doing so, he incurred personal liability. And the judge said that, look, the fact that no purchaser's authorization had been lodged by the company didn't mean that he was not bidding on behalf of the company, but it instead meant that by doing so, by making those bids, he couldn't avoid personal liability under the conditions of sale.

Now, the general rule is very much that directors are not normally personally liable for the acts of the company they represent. But in this case, the problem was the specific provisions of the auction house's conditions of sale meant that the director was liable, not because he was a director, but because he had been the individual bidding in the ring on behalf of the company. So under the conditions of sale, that personal liability could have been avoided by the company completing a purchaser's authorization and had it done that then presumably the auction house would have investigated the company as Mr. McMahon's principal and determined whether or not it was good for the money. But in the absence of that authorization, then the person bidding in the ring, even if he was doing so in his capacity as a director of the company, wasn't able to avoid personal liability. So a bit of a cautionary tale there to always be very clear about the capacity in which you are acting when acting as the director, and also to review any applicable contractual provisions, which may cut across the general rule that directors will not be personally liable.

Okay. And then the final case that I thought I'd mentioned relates to the limits placed on exercising a contractual discretion. So this is where you get wording in an agreement or a document, which allows one party to make a decision which affects others. So a classic one that we come across in relation to companies is in the articles of association, which often say something along the lines of, directors can refuse to register a transfer of shares in their absolute discretion. So does that mean that the directors can just decide what they want to do and there are no limits placed on how they must act? So for example, could they refuse to register a transfer to anyone whose name begins with the letter J? Or is there some element of reasonableness implied into how they must exercise their discretion when deciding whether or not to refuse to register a transfer of shares?

So the relevant case here is called Tribe versus Elborne Mitchell, LLP, and it involved a dispute relating to the allocation of profits at a law firm. So the firm's partnership agreement set out the basis on which the profits were to be allocated. And that included a discretionary fund, which was allocated by ordinary resolution of the partners on recommendations brought forward by the senior partner. So the agreement also said that the senior partner's recommendations were quote "to be determined at his discretion, but will have substantial regard for financial performance."

So one of the partners, Mr. Tribe, was unhappy with his allocation of profit for two particular years. So he brought a claim against the firm, which challenged the way in which the senior partner had made his recommendations for the distribution of the discretionary fund, and also challenged the basis on which the partners had passed an ordinary resolution based on those recommendations. So the court confirmed here that where a contractual term enabled one party to make a decision which affected the rights of all parties to that contract, then there's a clear conflict of interest. And the courts have therefore sought to ensure that that kind of contractual power is not abused by implying a term into the contract as to the manner in which that power can be exercised.

So in the current case, the court held that the senior partner had to exercise good faith when making his recommendations. He couldn't take into account irrelevant matters, and he couldn't ignore relevant ones. And also his proposals should not be outside the range of reasonable proposals that might be made in the circumstances. But generally the court said the senior partner had a very broad discretion, particularly because according to the contractual wording, all he was doing was making a proposal, which would then be discussed between the parties, rather than the senior partner just making the decision and that was it.

So his proposals, the court said could address matters other than financial performance. So things like efficient use of resources or the behaviors that partners wanted to reward, provided that substantial attention was paid to financial performance as required under the agreement. And the court said, look, when you're looking at financial performance, that's not limited just to partner billings, but it does include matters such as collection of bills, which may affect how the firm performed financially.

So when the partners subsequently voted to allocate the discretionary refund, the court said, well, they have to do that acting in good faith in the interest of the LLP. And again, they shouldn't take account of irrelevant matters or ignore relevant ones. And the decision has to be within the range of reasonable decisions that might be made in the circumstances of allocating the discretionary refund.

So applying all of those principles to the decisions that were made in this case, the court found that the senior partner's proposals for the allocation of the discretionary fund was within the range of proposals, that it was reasonable for him to make. His proposals also had substantial regard to financial performance so they were a valid exercise of the discretion given to that senior partner. And similarly, the court, they said that the allocation of the fund by agreement of the partners by ordinary resolution was also a valid exercise of their powers. So as a result of all of that, Mr. Tribe's claims for damages and declarations failed.

So I think that case is kind of a useful reminder that where a party is given a contractual discretion, there are limits placed on the manner in which that discretion may be exercised. It doesn't mean that the party can just do whatever it likes. So the power cannot be exercised arbitrarily or capriciously. For example, refusing to register a transfer of shares to someone whose name begins with the letter J. That's just an arbitrary exercise of that power and that wouldn't be valid. Instead, the discretion has to be exercised in good faith and consistent with the underlying contractual purpose. And I think you would need very clear words in an agreement or document to permit a party to exercise that kind of contractual discretion without taking those principles into account.

So it may be possible to in your contract ensure that you can overcome those principles. But as I say, I think you'd need very clear contractual wording to do that. And once you start writing into a contract, we can act in a way that is arbitrary and capricious then frankly, that's going to start ringing alarm bells for the other contractual parties and they're unlikely to accept that.

So that's it for this month's update email, hope you found that interesting. We're going to be taking a break over the summer and we'll be back with our next episode, probably towards the end of September. But in the meantime, you can catch up on any episodes you've missed via the insight tab on our website, gateleyplc.com.

Thank you for listening to Talking Business. To find out more about the series, please visit gateleyplc.com/podcast/talkingbusiness. From there, you can subscribe for all updates, meet our speakers and get more information on all of the topics being discussed.

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