05 Jul 2017

COT's top four commercial issues - June 2017

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With the election now finished and a semblance of a government formed, we can now concentrate on the real issues, the commercial, outsourcing and technology ("COT") team's monthly snapshot.

As always, grab a coffee (although a chilled beverage may be more suitable in the summer months) and take five minutes to enjoy.

As an aside, we have received some great feedback from our readers who have asked whether they can suggest topics to cover in our "snapshot" or "handy hints" sections and the answer is a comprehensive yes. Feel free to email your contacts or one of the COT team with any topics you would like covered and we will do our best to provide some insight.

Blockchain reaction

This month, IBM was appointed by a number of European banks to build and host a new trade finance system based on Blockchain technology to refresh the rather antiquated way trade finance is conducted between small and medium sized businesses.

While Blockchain technology is still a relatively new concept, this recent development is a significant step in the technology moving from the niche cryptocurrency of Bitcoin and Ethereum into the financial mainstream. Thankfully, we have been involved in a number of Blockchain initiatives recently so feel well equipped to enlighten those unfamiliar with the intricacies of Blockchain technology.

Essentially, Blockchain is a term used to describe a ledger/database that, rather than being a single ledger held in a central location, is a network of multiple copies of the same ledger shared or distributed amongst its members. Each member therefore holds an exact copy of the current ledger at any one time. Whenever there is a proposed update to the ledger e.g. a new transaction, this update is automatically broadcast to each participant of the Blockchain network, which validates the transaction based on its copy of the ledger. Once the transaction has achieved a majority consensus that it aligns with the majority of the participants' ledgers, this is then timestamped and recorded in these ledgers. This is then referred to as a block in the chain. Therefore, if one party tried to sell currency to another party in the network, but the majority of ledgers in the network did not recognise that the selling party had the currency to sell, the transaction would not be approved and it would not become a block on the ledger.

Many trade finance deals are often complex in nature and still reliant on centralised, paper-based records. This presents risks around security, authenticity and fraud with a number of examples of fraudulent financial transactions being conducted over assets that were not actually owned by the relevant party in the transaction. The benefit of Blockchain technology allows the functionality to give an asset a digital identity or "fingerprint", once it first enters the supply chain. This fingerprint can contain the relevant asset's details together with the current and past owners' details. This fingerprint can then be added to the Blockchain where the assets are traded so that each member is given a level of real-time transparency over the transactions being conducted over the assets.

An additional key benefit of Blockchain technology is the concept of "smart contracts", which the new IBM platform is proposing to use. While the term is slightly misleading, it is essentially code embedded within the Blockchain to allow pre-determined activities to occur on the trigger of certain events. This automation could simplify transactions to allow the payment to the seller from the buyer immediately once the predetermined rules have been met with the ledger being automatically updated, rather than rely on a manual process.

The biggest selling point of Blockchain technology is the immutable record it can present to its participants. However, while a decentralised ledger presents fewer risks than a centralised ledger, the difficulty over the next few years will be through education to convert people away from the paper-based manual approach, that they are familiar with, to a peer-to-peer automated approach if it is to have any real success in becoming mainstream.

Online portability

It used to be the case that when we went abroad on holiday, despite the blissful respite that it provided from our everyday lives, it was easy to feel cut adrift from our home comforts. None of the music, games or matches that we would normally have enjoyed at home were available and some of us were left struggling to make sense of the local culture. Well, the Council of the EU has come to our rescue. It announced on 8 June 2017 that it had voted to adopt a proposed Regulation on the cross-border portability of online content services in the Internal Market.

"But what does this mean for my holiday entertainment services?", we hear you ask. Well, the Regulation will ensure that residents of EU member states can access content that they have legally acquired or subscribed to at home whenever they are abroad within the EU on holidays, business trips or limited student stays. The types of content services that EU residents will be able to enjoy when travelling in other member states include paid-for films, sporting broadcasts, music, e-books and games. Free to air services that verify their subscribers' country of residence may also benefit.

And content providers can't get around this by charging more or providing a worse service – they must provide access to the same content, on the same range and number of devices, for the same number of users and with the same range of functionalities as the user gets at home and they may not charge extra for the privilege. However, it may be some comfort to content providers that they will be able to seek to verify subscribers' member state of residence and may prevent access to the online service if EU residence cannot be proved.

The bad news? The Regulation is not likely to come into effect until early 2018. Too late to enable you to spend this summer binging on films instead of admiring the scenery. Although this timescale should allow UK residents to spend their 2018 summer holidays making the most of what could be their last year of EU membership rights. If content portability proves popular with UK residents, it could become one more issue for the government to add to the Brexit negotiations to do list.

Digital supply

June has obviously been a busy month for content rights holders, as along with the changes referred to above relating to online content, the European Parliament’s Justice and Home Affairs Council have been busy finalising their approach on the proposal for a Directive on contracts for the supply of digital content.

The Directive, originally proposed in 2015 alongside the adoption of the EU’s Digital Single Market strategy, seeks to regulate business-to-consumer contracts for the supply of digital content by putting in place a harmonised set of rules, thereby giving European customers a higher level of consumer protection and legal certainty. The European Parliament also hopes that by eliminating contract law related barriers to cross-border trade, the Directive will reduce costs of legal compliance incurred by businesses operating across various member states (and navigating the intricacies of each of their national laws).

The key elements of the Council's general approach are as follows:

  • The scope of the Directive will include "over the top" interpersonal communication and messaging services delivered over the Internet rather than over traditional telecommunications services (OTTs), bundle contracts which contain elements of supply of digital content as well as other services or goods (to the extent the contract concerns digital content or services) and the processing of personal data.
  • Acknowledging the increased value of personal data in business models, consumers should be entitled to contractual remedies not just where they have paid a price, but also where they have exchanged only their personal data in return for digital content or service. The Directive is not expected to apply where a consumer has not provided payment or personal data to the supplier, or where no commercial use is made of the personal data by the supplier.
  • In cases where the supplier has failed to supply to consumers, suppliers should be allowed a "second chance" before the contract can be terminated.
  • On non-conformity, the text provides more flexibility for the implementation at national level by setting out the conditions for the use of different remedies (e.g. bringing into conformity, price reduction, termination of the contract) rather than establishing a strict hierarchy between them.
  • In order to take into account the differences at national level, the text does not fully harmonise prescription or guarantee periods, but does set out that the liability of the supplier for cases of lack of conformity may not be shorter than two years.
  • The period during which the burden of proof for lack of conformity sits with the supplier is set at one year, at which point the burden of proof will reverse.

The proposed Directive is being adopted under the ordinary legislative procedure, so the European Parliament and Council will now use this general approach as the basis for negotiating and agreeing upon the final text. Negotiations will begin once the European Parliament has adopted its position, which is likely to be during the autumn.

What will be interesting to understand is how some of these provisions are adopted and integrated within member states' existing consumer protection legislation.

Variation by implication

The Court of Appeal recently dismissed the argument that an express variation of contractual terms had resulted in the implied variation of other contractual provisions.

In Ilkerler Otomotiv & Anor v Perkins Engines Company Ltd [2017] EWCA Civ 183, the claimant, a Turkish distributor had entered into a distributor agreement with the defendant, an English company designing, manufacturing and supplying engines on 1 May 2000. The defendant gave notice of its intention to terminate the distributor agreement on March 31, 2013.

The first key termination clause, which is the clause that the defendant terminated under, stated that unless terminated under the other key termination clause below, the agreement would remain in force for an initial period of 3 years, following which it should continue in force unless terminated by either party giving at least 6 months' prior written notice. The other key termination clause stated that if the defendant was dissatisfied with the distributor's performance, it should notify the distributor in writing and the distributor would have 3 months to remedy its actions. If the distributor failed to remedy the performance the defendant could terminate the agreement.

The court agreed that, despite the fact the defendant terminated the agreement using the termination for convenience clause; it was the defendant's dissatisfaction with the distributor's performance, which was the reason for terminating. However, despite the defendant's motivations, the Court rejected the claimant's argument that the defendant should have given the claimant the opportunity to remedy their action under the second key termination clause, rather than terminating for convenience, due to a previous variation of the agreement.

The court agreed that the agreement had been expressly varied: (i) with a subsidiary of the claimant becoming a party to the distributor agreement; and (ii) the claimants were required to adopt longer term plans than initially envisaged, which would require them to make substantial investments into the distributor business. However, their arguments that this consequently led to an implied variation that the notice to terminate could not take effect before the end of the revised plan or (if earlier) when the claimants had recouped their increased investment, were rejected.

The court held that the express and implied variations must be consistent with each other in order to rely on an argument that a term should be implied because the claiming party is worse-off due to another clause. On these facts, this was not found to be the case.

In summary, the Court of Appeal has set a fairly high bar on the circumstances in which an express variation of a contract will also lead to an implied variation. Nonetheless, it is important to consider, when amending agreements (whether in writing or by conduct), whether the agreed variation is likely to have a knock-on effect on your other existing contractual provisions.

 

Handy hints - Enforceable penalties

When drafting or reviewing a liquidated damages clause or provisions imposing service credits, you might still come across the phrase “the parties agree that this is a genuine pre-estimate of loss” where a party is seeking to avoid a clause being considered a penalty. In fact, the Supreme Court replaced this test in a 2015 decision (see Cavendish Square Holding BV v El Makdessi and ParkingEye Ltd v Beavis [2015] UKSC 67). The rule is now narrowly confined to provisions triggered by a breach of contract. It does not apply to primary obligations, such as price adjustment clauses. Additionally the rule is based on whether (i) a party’s commercial interest in applying liquidated damages is legitimate; and (ii) if such liquidated damages are reasonable and proportionate to protect that interest. You might now consider drafting a clause recording the relevant legitimate interest and the parties’ agreement that such a clause is reasonable and proportionate. Don’t forget that if the amount imposed is excessive (or “extravagant or unconscionable”), your clause is unlikely to be effective; however you seek to present otherwise.

One key drafting tip is to re-structure the clause, to the extent possible, as a price adjustment clause that reflects an agreement to reduce any consideration under the contract (a “primary obligation”), as this is not subject to the penalty rule.

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Dan Holland

Dan Holland
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Anita Basi
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David Berry

David Berry
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Katie Hewson
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Alison Kenney

Alison Kenney
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