19 Jun 2020

Commercial and tech update - June 2020

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Welcome to this month’s edition of our commercial and tech update, which includes significant changes to a supplier’s right to terminate for a customer’s insolvency, as well as a cautionary tale on rectification.

Changes to termination rights in supply contracts

The Corporate Insolvency and Governance Bill (“Bill”) was announced on 20 May 2020 and is currently going through Parliament. One of the changes to UK insolvency law introduced by the Bill includes a prohibition on a supplier’s entitlement to terminate a supply contract where a customer suffers an insolvency event on or after the date on which the Bill comes in to effect; a right that is commonplace in supply contracts. This means that suppliers must continue to supply goods and services to a customer entering a “relevant insolvency procedure”.

A relevant insolvency procedure means: a moratorium, administration, administrative receivership, approval of a company voluntary arrangement; liquidation or provisional liquidation; or a convening order under the new reorganisation measure set out in the Bill.

The supplier will be prevented from: (i) terminating a supply contract or doing “any other thing” because the customer has entered a relevant insolvency procedure; (ii) terminating a contract or supply for breaches which occurred prior to the relevant insolvency procedure; or (iii) making it a condition of future supplies that pre-insolvency debts are paid.

However, suppliers will still be entitled to terminate: (i) for new breaches that happen after the insolvency procedure begins (which can include the customer’s breach of its payment obligations); (ii) with the consent of the customer or the insolvency office holder of the customer (depending on the relevant insolvency procedure); or (iii) with the permission of the court, provided that the court is satisfied that continuation of the contract would cause the supplier hardship. “Hardship” is not defined, so this test, which could provide a safeguard to suppliers, remains to be clarified in court.

“Small entities” will be exempt from the provisions of the Bill for one month following the law coming into effect. A small entity is an entity that meets at least two of the following conditions in its most recent financial year: (i) turnover was not more than £2 million; (ii) balance sheet was not more than £1 million; or (iii) not more than 50 employees. These new provisions also won’t apply where the customer or the supplier are involved in financial services (for example, either party is a bank or an investment firm) or where the relevant supply contract involves the provision of finance (for example, a loan agreement or swap agreement).

For customers, the Bill will support them in continuing to trade through an insolvency procedure to maximise the possibility of rescuing the company, which is undoubtedly positive for both customers and suppliers. However, suppliers will not be able to contract out of these provisions and therefore may want to consider: (i) their exposure to vulnerable customers; (ii) other termination rights available to them under their supply contracts (such as termination for convenience and other events of default or material breaches); and (iii) whether they should demand upfront payments for any new contracts entered in to.

The Bill is expected to receive royal assent this month or in early July.

Rectification not available if the benefit was not originally contemplated

In the case of MV Promotions Ltd and another v Telegraph Media Group Ltd and HMRC [2020] EWHC 1357 (Ch), the High Court held that there could be no remedy of rectification if all issues between the parties had been resolved and rectification was sought only to achieve a tax benefit that the parties had not originally contemplated at the time of entering into the contract.

The former international cricketer, Mr Michael Vaughan, entered into a contract in 2008 with Telegraph Media Group Ltd (“TMG”) through his personal service company, MV Promotions Limited (“MVP”). The contract provided for MVP to secure that Mr Vaughan, amongst other things, write regular newspaper articles for TMG. When that contract ended, the arrangement was extended under a new contract dated 24 June 2011, stated to be between TMG and Mr Vaughan himself, not MVP. In 2018, the parties entered into a rectification deed setting out their intention that the 2011 contract was actually between MVP and TMG.

In the proceedings, MVP and Mr Vaughan sought a declaration that, on the true interpretation of the 2011 contract, the contracting parties have, since its inception, been MVP and TMG; alternately, a declaration that the 2011 contract shall be rectified such that the contracting parties have, since the inception of the 2011 contract, been MVP and TMG. HMRC was joined as a defendant to the proceedings since they had an interest in the outcome given that Mr Vaughan’s self-assessment tax returns would have increased due to the services he provided under the 2011 contract if it was with him directly. Mr Vaughan, MVP and TMG confirmed that their intention when entering into the 2011 contract had been that TMG was to contract with MVP (not Mr Vaughan directly), whilst it was HMRC who disputed that the rectification deed applied with retrospective effect and was therefore entitled to claim tax from Mr Vaughan under the 2011 contract.

The judge was satisfied that the claimants had proved the necessary preconditions for the equitable remedy of rectification on the basis of common mistake; however’ the case turned on the exercise of the court’s discretion. The court held that rectification was being sought in order to achieve what was now thought to be a tax-efficient structure. The parties had no intention to utilise this structure when they entered into the 2011 contract. In addition, the parties had entered into the rectification deed in 2018, so there was nothing left to rectify. The court noted that the rectification deed did not bind HMRC and by using its discretion to grant rectification, it could be deemed as going against one of the maxims of equity that “equity does not act in vain”. It was therefore held that these circumstances were not appropriate for the court to exercise its discretion to grant rectification and HMRC was entitled to claim the higher tax returns due under the 2011 contract.

This case highlights the power of court’s discretion and acts as a warning that rectification may be withheld even where the parties have sought to correct any relevant mistake themselves.

Consumer rights also apply to students

In April the Competition and Markets Authority (“CMA”) issued guidance which stated that consumers could receive partial refunds where they have not been provided with all of the services that they contracted for (click here for our coverage in last month’s edition).

The CMA stated that consumer law usually requires “the consumer to be offered a refund for any services they have already paid for but that are not provided by the business or which the consumer is not allowed to use because of Government public health measures (this may be a partial refund of the total amount the consumer has paid, to reflect the value of the services already provided)”.

Universities are, whilst education providers, at their core providers of services to consumers. In 2010 there were widespread protests in reaction to the increase in tuition fees and, since the increase in fees, students are far more concerned about the standard of service they are receiving.  Therefore, during lockdown when most courses moved to online learning, students were rightly questioning whether they would receive value for money.

It is no surprise therefore that the CMA has confirmed separately that its guidance applies to students and universities, including both international and domestic students at UK universities. Michelle Donelan, Minister of State for Universities, tweeted that the Government “only expects full tuition fees to be charged if online courses are of good quality, fit for purpose & help students progress towards their qualification. If [universities] want to charge full fees they will have to ensure that the quality is there”. Therefore it may be that universities that offer more practical based courses are the ones that are hit the hardest.

However, it has been widely reported that universities are facing a staggering £2.5bn tuition fee loss next year as there is a risk of fewer students starting in the Autumn. Despite the huge losses they are facing, they are still helping communities and the NHS to fight Covid-19 by testing vaccines and donating equipment. So, after consultations with Universities UK, the Government announced a support package, which includes bringing forward access to funding and tuition fee payments. However, importantly, no new funds were ring fenced.  Universities will therefore be keen to hold on to as much of their current tuition fees as possible, but, there is a difficult balance that needs to be struck between consumer rights and ensuring that universities can still play their vital role in the community.

Further guidance on outsourcing in the financial services sector

Earlier this month, the European Securities and Markets Authority (“ESMA”) published its draft guidelines on outsourcing to cloud service providers (“Draft Guidelines”) for consultation. Cloud solutions are becoming increasing popular for many firms, but the regulator is concerned that the risks presented by cloud outsourcing may not receive enough attention at senior board level. There are also fears that regulated firms may become overly reliant on cloud service providers and that insufficient due diligence is being carried out by regulated firms, which is a matter of particular importance where service providers are offering a ‘one-size-fits-all” solution with regard to data and business processes.

The Draft Guidelines, once finalised, will apply to competent authorities and various financial market participants. They are intended to help regulated firms and competent authorities to identify, mitigate and monitor the risks and challenges that arise when outsourcing to cloud service providers. The Draft Guidelines set out:

  • the governance, oversight, documentation and monitoring procedures that regulated firms should have in place;
  • factors that should be considered in pre-outsourcing analysis and due diligence;
  • minimum contractual requirements that should be addressed in written agreements for the outsourcing of critical or important functions;
  • steps to be taken with regard to information security;
  • exit strategies that should be implemented;
  • access and audit rights that should be taken into consideration;
  • requirements to be addressed if sub-outsourcing of critical or important functions is permitted by the firm;
  • an obligation on regulated firms to notify their competent authority of any planned outsourcing of critical or important functions; and
  • the roles and responsibilities of competent authorities with regard to supervising cloud outsourcing arrangements.

Some firms will need to comply with other regulatory guidelines alongside the ESMA guidelines, such as the European Banking Authority’s (“EBA”) guidelines on outsourcing arrangements and the European Insurance and Occupational Pensions Authority’s guidelines on outsourcing to cloud service providers. However, ESMA has confirmed that it considered these guidelines when putting together the Draft Guidelines, and it should be noted that the Draft Guidelines are not as extensive or prescriptive as the EBA guidelines on outsourcing arrangements.

The Draft Guidelines will be open for consultation until 1 September 2020, and are expected to be finalised by the end of Q1 2021 before eventually taking effect from 30 June 2021. Regulated firms will be required to review and amend their existing cloud outsourcing arrangements to ensure that they are compliant with the finalised guidelines by the end of 2022. Where regulated firms have not finalised their review by the end of 2022, they will need to inform their competent authorities of this, together with measures planned to complete the review or a possible exit strategy.

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