uk INVESTMENT

LEGAL GUIDE investing in the Fifth edition

UK for Chinese 2014 investors

Contents

page Introduction ...... 02 Herbert Smith Freehills ...... contacts ...... 03 01 Introduction to the English legal system ...... 05 02 Foreign investment – restrictions ...... 07 03 Regulations and procedures of English companies – basic company law ...... 09 04 The differences between a private company and a public company . . 19 05 Acquisitions of private companies ...... 22 06 Takeovers of public companies ...... 25 07 Restrictions on acquiring regulated businesses ...... 32 08 Financial services regulation ...... 40 09 Raising finance ...... 43 10 Competition law ...... 50 11 Merger control ...... 53 12 Employees ...... 57 13 Tax ...... 66 14 Intellectual property ...... 73 15 Commercial agreements ...... 77 16 E-commerce ...... 80 17 Privacy and data protection ...... 83 18 Product safety and liability ...... 86 19 Money laundering ...... 90 20 Litigation ...... 93 21 Arbitration ...... 98 22 Alternative dispute resolution ...... 101 23 Acquiring and investing in property ...... 102 24 China’s overseas investment rules ...... 106 Appendix of abbreviations ...... 115 02 Introduction HERBERT SMITH FREEHILLS

Introduction

The United Kingdom (UK) has successfully retained its leadership position in Europe for inward investment .

The UK’s financial and professional services and the English law, like all legal systems, is subject to regular strength of London remain a powerful draw and it is change . What you read here reflects the law at the still the most attractive destination for foreign direct date we published this guide . We intend to update investment into Europe . The UK attracted 1559 the guide periodically, but please be careful to check foreign direct investment projects during the with us, before relying on it, that the law as stated 2012/13 financial year, 11% higher than in 2011/12 1. here is still in force .

Initially, the legal system in the UK, the way in which We would welcome the opportunity to discuss any investment in companies is made, the restrictions of these issues with you . Please feel free to get in on acquiring businesses in the UK and the rules on touch with your usual Herbert Smith Freehills money laundering, financial services, employment, contact or one of the partners named overleaf . tax law and other areas, can be difficult to understand . Herbert Smith Freehills LLP 2014 We hope that you will find this Herbert Smith Fifth edition Freehills guide useful in explaining the key legal issues affecting your planned or existing investment in the UK . It aims to explain those legal areas to the overseas investor and act as a glossary or step by step guide for the reader . It is very much an introduction to the subject and is not intended to be a comprehensive guide to all legal issues .

1 Source: UK Trade & Investment (the government department responsible for attracting inward investment to the UK) Inward Investment Report 2012/13 https://www.gov.uk/government/publications/ukti-inward-investment-report-201213. HERBERT SMITH FREEHILLS Herbert Smith FREEHILLS CONTACTS 03

Herbert Smith Freehills contacts

Herbert Smith Freehills LLP Herbert Smith Freehills is the largest fully integrated law firm in Asia Pacific and is one of the world’s top ranked and most experienced energy and resources firms; a globally pre-eminent and recognised firm in litigation, arbitration and contentious regulatory work; and an international leader in M&A, private equity, capital markets, infrastructure and banking and finance .

London office: Beijing office: Exchange House 28/F Office Tower Primrose Street Beijing Yintai Centre London 2 Jianguomenwai Avenue EC2A 2EG Chaoyang District Beijing 100022 People’s Republic of China Shanghai office: 38/F Bund Center 222 Yan An Road East Shanghai 200002 People’s Republic of China

London Corporate Competition, Intellectual regulation and trade Property Scott Cochrane T +44 20 7466 2236 James Quinney Mark Shillito scott .cochrane@hsf .com T +44 20 7466 2469 T +44 20 7466 2031 james .quinney@hsf com. mark shillito@hsf. com.

Litigation Employment Financial Services Tim Parkes Regulation T +44 20 7466 2001 Andrew Taggart tim parkes@hsf. .com T +44 20 7466 2434 Clive Cunningham andrew taggart@hsf. .com T +44 20 7466 2278 Finance clive .cunningham@hsf .com Tax Malcolm Hitching Real Estate T +44 20 7466 2687 Isaac Zailer malcolm hitching@hsf. .com T +44 20 7466 2464 Donald Rowlands isaac .zailer@hsf .com T +44 20 7466 2287 Arbitration donald rowlands@hsf. .com Paula Hodges QC T +44 20 7466 2027 paula hodges@hsf. .com 04 Herbert Smith FREEHILLS Contacts HERBERT SMITH FREEHILLS

Herbert Smith FREEHILLS contacts

Greater China Editors

Julian Copeman Simone Pearlman Managing Partner, Greater China T +44 20 7466 2021 T +852 21014245 simone pearlman@hsf. .com julian .copeman@hsf .com

Emily Lew Tom Chau T +44 20 7466 2562 Head of Office, Beijing emily lew@hsf. .com T +86 10 6535 5136 tom .chau@hsf .com

Brenda Horrigan Head of Office, Shanghai T +86 21 2322 2112 brenda horrigan@hsf. com.

Owen Cox Professional Support Lawyer T +86 21 2322 2151 owen .cox@hsf .com

Defined terms: See Appendix of Abbreviations at the end of this guide .

With thanks to the large team of partners, professional support lawyers and associates who have made this publication possible.

Fifth edition first published in July 2014

Herbert Smith Freehills LLP is licensed to operate as a foreign law firm in China by the Ministry of Justice. Under Ministry of Justice regulations, foreign law firms in China are permitted, amongst other things, to provide consultancy services on non-Chinese law and on international conventions and practices, and to provide information on the impact of the Chinese legal environment. Under the same regulations, foreign law firms in China are not permitted to conduct Chinese legal affairs, including rendering legal opinions upon Chinese law. The contents of this publication do not constitute an opinion upon Chinese law. If you require such an opinion you should obtain it from a Chinese law firm (we would be happy to assist in arranging this).

The contents of this publication, current at the date of publication set out in this document, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.

© Herbert Smith Freehills LLP 2014 HERBERT SMITH FREEHILLS Introduction to the English legal system 05

1. Introduction to the English legal system The following is a brief overview of Judges may interfere with the decisions of the executive, that is, with the decisions of ministers, the English legal system which is many regulators and official bodies that are historically derived from what is empowered to make administrative decisions . This is known as the common law . typically on the basis that those administrative or government agencies have failed to exercise their THE LEGAL SYSTEM (CIVIL LAW, discretion or decision-making power appropriately or COMMON LAW OR A MIXTURE OF BOTH) reasonably or in accordance with their own protocols or operating principles . This is known as the principle Scotland, England and Wales, and Northern Ireland of judicial review . Judges therefore maintain a great are largely separate jurisdictions for legal purposes . deal of influence on the balance of power in the Scotland has a mixed common law and civil law English legal system . system whereas England and Wales and Northern Ireland have a common law system . THE BASIC DIFFERENCES BETWEEN CIVIL LAW AND COMMON LAW SOURCES OF ENGLISH LAW The English legal system is based on the common The rules governing civil and criminal law have law . The legal systems of other European countries evolved from three sources: are based on civil codes – books defining what can Legislation – which includes statutes/Acts of and cannot be done . Parliament . Legislation is approved by the Queen before it becomes law . The differences between practising in a civil or a common law system are huge, affecting not only the Common law – made by judges . It has evolved over ways that laws are made but the way in which lawyers centuries from the judgment of cases appearing think and the make-up of the personnel within the before the courts . These judgments set precedents courts . For example in the common law system, against which future cases are judged . There are English judges in a very real sense make the law on the also specialist tribunals (for example, for tax) but job: they interpret and apply, usually relying closely on decisions of tribunals are not generally binding on established precedent (the principles laid down in other tribunals so have limited precedential value . older cases), but in doing so they create the law . On They prove useful for understanding how the law the other hand, within the civil law system, codes are may be interpreted . typically constructed and commented upon by panels European Union (EU) law which is binding in all UK of legal scientists or academics, whose work is crafted legal systems . to a great design, with detail flowing naturally from basic principles . The role of the judges in a codified The interpretation of legislation made by Parliament system is then to apply and interpret the handiwork of is for the courts when they hear cases . When the great codifiers . conflicts arise between common law and legislation, these are dealt with by the courts, with legislation One important difference that results is the principle taking priority over common law . Parliament is held of freedom of contract . While there are some to be sovereign . Where EU law conflicts with national legislative provisions and principles of case law law, the UK courts are required to apply the EU law or restricting what parties can and cannot put into to interpret national law to fit in with EU law . contracts, essentially English law allows parties to a contract to write their own terms and conditions . The 06 Introduction to the English legal system HERBERT SMITH FREEHILLS

Introduction to the English legal system

agreement that results is a matter for their negotiation and reflects the individual circumstances of their transaction . This gives great flexibility to parties in writing and concluding commercial contracts when relying on English law . Legal principles developed by the English judges over centuries determine how certain phrases and clauses should be interpreted in English law, and draftsmen must be careful to take these into account when preparing contracts . But the essential point is that no party has to start from a fixed template or prescribed set of terms when seeking to conclude a commercial deal or transaction under English law .

The material in this guide relates only to the laws of England and Wales unless otherwise stated . HERBERT SMITH FREEHILLS Foreign investment – restrictions 07

2. Foreign investment – restrictions

Most foreign investment into the UK broadly speaking, the activities of the partnership are treated as carried on by the members and not is not regulated . However, the partnership itself . Accordingly, the partnership authorisation is required for as a whole does not pay tax, the partners are taxed investment in sensitive areas, such separately on their share of the profits and losses of the partnership as though each partner was as defence, and regulated areas, carrying on a separate trade . such as banking, media and financial Limited liability partnership (LLP) – An LLP has the services . These are covered in more flexibility of a partnership with the added advantage detail in Chapter 7 below . of limited liability for its members . Legally, an LLP is a separate legal entity from its members and can contract in its own name . For tax purposes, it is Foreign investors should be aware of EU competition treated as a partnership . It has to comply with law rules and sector-specific policies . Some company, rather than partnership, law . reference is made to these in Chapter 10 below . Company – A company is an artificial legal person EXCHANGE CONTROL OR CURRENCY with a separate legal identity from that of its REGULATIONS owners/shareholders . The company may In the UK, there are no exchange control or currency therefore enter into contracts in its own right . If the regulations affecting inward or outward investment, company becomes insolvent it will be wound up the repatriation of income or capital, the holding of and any assets divided amongst the creditors but currency accounts or the settlement of currency creditors are not able to access the assets of the trading transactions . However, there are separate shareholders . A company can have another restrictions relating to the provision of funds to, or company (or companies) as its shareholder(s) and dealing with the assets of, sanctioned individuals and therefore may fall to be treated as its shareholder entities (such sanctionscan either be country specific company’s subsidiary . There are different types of or involve the designation of individuals and entities companies, which are explored further in believed to be connected to terrorist activity) . Chapters 3 and 4 . The most common form of corporate vehicle established by foreign TYPES OF BUSINESS VEHICLES companies in the UK is a private limited liability company . For tax purposes, companies are treated Partnership – Partnerships are defined but they as opaque which means they are taxed separately have no separate legal personality . A partnership is from their shareholders . unable to contract in its own name and therefore it is individual partners who enter into contracts Joint venture – A joint venture is a collaborative jointly . This means that if a partnership becomes commercial arrangement between two or more insolvent, the creditors are entitled to satisfy debts parties to work towards a common business goal . owed to them by enforcement against the personal It is not strictly a business vehicle as it can be assets of each of the partners themselves; partners structured in different ways – as a company, have unlimited personal liability . For tax purposes, partnership or through a simple a partnership is transparent which means that, contractual arrangement . 08 Foreign investment – restrictions HERBERT SMITH FREEHILLS

Foreign investment – restrictions

Branch – A branch is not a company but is an operation of an overseas company in the UK . It cannot contract in its own name but rather acts as agent for its overseas company . A branch (or a place of business, both a “UK establishment” for the purposes of the Companies Act 2006) must file certain details with the Registrar of Companies in England and Wales .

Significant tax consequences may flow from the decision to use a partnership, LLP, company or joint venture or branch (permanent establishment) and early advice should always be sought .

A business may be located anywhere in the UK, provided that necessary building permits and planning consents are obtained (see Chapter 23 below) . HERBERT SMITH FREEHILLS Regulations and procedures of English 09 companies – basic company law

3. Regulations and procedures of English companies – basic company law A company is a distinct legal entity, through case law . This body of case law is known as the common law . separate from its shareholders (or members), directors and employees, Financial services law which can own property, enter into The Financial Services and Markets Act 2000 contracts and sue and be sued in its (FSMA) sets out the UK regime for financial services and securities law . In particular, there are restrictions own name . However, as it has no on offering or promoting securities and companies physical corpus, it must operate need to produce a prospectus when they offer their shares to the public (subject to certain exceptions) . through others, principally the See Chapter 4 for further details . shareholders as a body and the board of directors . In addition, companies whose shares are traded on the Official List will need to comply with the Listing, THE LEGAL FRAMEWORK Prospectus, Disclosure and Transparency Rules issued by the Financial Conduct Authority (FCA) . The rules governing the operation of a company These govern the requirements for admission to incorporated in England and Wales are to be found in listing, the continuing obligations of listed companies the following principal sources: and the obligation to prepare, and the contents of, a prospectus on admission of securities to trading . For Companies Act 2006 companies admitted to AIM (the Alternative The UK company law regime is set out in the Investment Market), the equivalent requirements are Companies Act 2006 (the Companies Act) . The 2006 set out in the AIM Rules for Companies, issued by Act has been fully in force since 1 October 2009 . the London Stock Exchange . All companies whose shares are traded on a stock exchange must also It should be noted that for companies incorporated comply with the rules of the relevant exchange . prior to 1 October 2009, there are some transitional provisions which mean that the Companies Act TYPES OF COMPANIES applies in a different way to those companies . This The following types of companies can be formed and summary focuses on UK company law as it applies registered in England and Wales: to companies incorporated after 1 October 2009 and does not cover the transitional provisions for Private companies limited by shares companies incorporated before that date . This is the most common type of company . The Insolvency Act 1986 phrase “limited by shares” means that, in the event of the company going into liquidation and being This Act contains provisions relating to the unable to pay its debts, the liability of the insolvency and winding up of companies . shareholders of the company is limited to the extent of payment of the nominal value of the shares Common law issued to those shareholders . Parts of the law relating to English companies has no statutory basis but has been established by judges 10 Regulations and procedures of English HERBERT SMITH FREEHILLS companies – basic company law

Regulations and procedures of English companies – basic company law

Public companies limited by shares REGISTRATION FORMALITIES Only public companies are authorised to offer In order to form and register an English company securities to the public – a private company cannot certain documents must be submitted to the Registrar do so . See Chapter 4 below for the main differences of Companies, known as Companies House: between public and private companies . the constitutional documents for the company, Private companies limited by guarantee that is to say its memorandum and articles of and not having a share capital association; and These are not common – they are normally an application for registration (which includes non-profit making organisations . certain information about the company such as the proposed name, whether the company will be Private unlimited companies public or private, a statement of proposed officers and a statement of intended registered office) These companies do not have any limit on the and a statement of compliance confirming that members’ liability in the event of the company going the company has been validly put forward into liquidation and being unable to pay its debts . for registration . They are therefore not used very often . Companies House provides a certificate of Societas Europaea (SE)/European Company incorporation . Standard registration using the paper form takes 8-10 working days and costs £40 . It is also possible to form a public limited liability However, a company can also be incorporated on a company called the Societas Europaea, known as the same day basis for a fee of £100 . Electronic SE (or European Company) . The SE can be used by registration costs £15 . companies or groups with operations in more than one Member State of the EEA and is registered in Once the company has been incorporated and one of these Member States . SEs are governed by registered, it is a distinct legal entity, separate from Council Regulation 2157/2001/EC and in the UK by its members . A person who purportedly contracts in the European Public Limited Liability Company the name of, or as agent for, a company before its Regulations (SI 2004/2326) . incorporation, however, incurs personal liability unless there is an agreement to the contrary . SEs are not companies formed under the Companies Act but certain provisions of law which govern public CONSTITUTIONAL DOCUMENTS limited liability companies formed and registered in Memorandum of association the UK may apply to SEs registered in the UK, where the matter is not addressed in the Council Regulation Each company must have a memorandum of and the intention behind the Council Regulation is association . Under the Companies Act, the that the matter should be governed by national law . memorandum of association is a short, standard document simply stating that the subscribers wish to form a company, agree to become members of the company and subscribe for at least one share each . The memorandum of association is therefore merely a historical document with no continuing operation and does not form part of the company’s constitution . HERBERT SMITH FREEHILLS Regulations and procedures of English 11 companies – basic company law

Articles of association STATUTORY BOOKS Every company must have articles of association . The company must keep certain statutory books The articles govern the internal affairs of the and records: company and regulate a great range of matters Register of members This contains the names and (subject to the requirements of the Companies Act) . addresses of shareholders and the number of These include the rights attached to the company’s shares held by each shareholder in the company . If shares (including voting rights), the powers of the there are joint holders of shares, the register must directors, the regulation of shareholders’ and show the name of each joint holder . On a transfer directors’ meetings, the alteration of capital and the of shares, the transferee does not become a transfer of shares . member until his name is registered as a member in the register of members, which the company is Under the Companies Act, there is no requirement not allowed to do until the stamp duty has been for a company to have a statement of its objects and paid (or the transfer has been certified as being a company’s objects are completely unrestricted exempt from stamp duty) . Stamp duty is not unless they are expressly limited by the articles payable however on an issue by the company of of association . new shares . The register of members must be open for inspection to the public but inspection is The articles of association constitute a contract only permitted by a person who has a proper between the company and its members . They may purpose for the inspection . be altered by a special resolution of the shareholders (subject to any special entrenched provisions in Register of directors and secretaries Directors and the articles) . secretaries are able to use a service address (which can be the company’s registered office) for the Regulations made under the Companies Act, the public register rather than a residential address . This Companies (Model Articles) Regulations 2008, register must be kept open to public inspection . SI 2008/3229, set out three sets of model form Register of directors’ residential addresses This articles of association, for private companies limited is the separate private register of directors’ by shares, private companies limited by guarantee residential addresses . and public companies . These apply as the default articles of association for companies of that type Register of charges over the company’s assets incorporated under the Companies Act, but can be The company must keep a register of all charges either excluded completely in favour of a bespoke set specifically affecting property of the company and of articles or adopted with variations . all floating charges over the undertaking or any property of the company . This register must include a short description of the property charged, the amount of the charge and the names of the persons entitled to it . In addition, particulars of charges (including any floating charge) must be registered with the Registrar of Companies within 21 days of creation of the charge . If a charge is a fixed charge over the company’s land, the charge must also be registered at the Land Registry or Land Charges Registry . 12 Regulations and procedures of English HERBERT SMITH FREEHILLS companies – basic company law

Regulations and procedures of English companies – basic company law

Directors’ service contracts These must be kept company’s articles of association and any available for public inspection and members may shareholders’ agreements . request copies . Share capital Minutes of general meetings and minutes of board meetings and copies of any written There is no ceiling on the number of shares that a resolutions of the company or the board company can issue provided that there is no limit under the articles and the directors have the Adequate accounting records necessary allotment authority (as described below) .

The statutory books must be kept at the company’s A company’s issued share capital is the number of registered office, or at one other location (which shares actually subscribed for and issued by must be notified to the Registrar of Companies) in the company . the part of the UK in which the company is registered (or partly at the registered office and partly at the Classes of shares other location) . The rights attaching to each class of shares in the REPORTING REQUIREMENTS company are set out in the articles of association of the company . There are no limits on what these class A company must submit an annual return and annual rights can be; there can be an infinite number of accounts to Companies House . All annual returns variations . However, there are customary must be delivered to Companies House within classifications and classes of shares which are 28 days of the made-up date given on the relevant regularly used . form . There is an annual document processing fee of £40 (or £13 if delivered electronically) . It is a criminal The common classes of shares are: offence not to deliver the company’s annual return within 28 days of the made-up date . There is no Ordinary shares – Every company will normally charge for filing the company’s annual accounts, have an ordinary share capital . This is the basic although there is an automatic civil penalty (in the type of capital which will form the basis of the form of a statutory fine) for late filing of accounts . rights of the other classes of shares . Ordinary shares will typically have a right to vote at all A company must also notify Companies House as general meetings, have a non-preferential, but and when there are any changes to its particulars, unlimited, right to participate in the profits in the such as the registered office, directors or changes in company and have a non-preferential, but share capital (including any new issue of shares) . In unlimited, right to participate in any surplus assets addition certain shareholder resolutions must be on a winding-up . filed at Companies House (see the paragraphs on Preference shares – Preference shares will generally resolutions later in this Chapter) . not have a right to vote at general meetings of the company except in special circumstances . SHARES Preference shares will rank in priority to ordinary The share capital of a UK company comprises shares shares both as regards the right to receive a dividend of a specified nominal amount which may or may not and the right to be repaid capital on a winding-up . be divided into separate classes . The rights attaching However, the rights of the preference shares are to shares are imposed by the Companies Act, the generally limited: the right to the dividend will be HERBERT SMITH FREEHILLS Regulations and procedures of English 13 companies – basic company law

fixed and on a winding-up the preference for public companies, the directors are required shareholders do not generally have any right to under the 2006 Act to have authority to issue new participate in any surplus assets . shares, either by a provision in the company’s articles of association or by an ordinary resolution of its Non-voting shares – There could be another class shareholders . The Companies Act also contains of shares which have identical rights to the pre-emption rights for shareholders on the issue of ordinary shares except that they have no right to new shares for cash (but not for any other vote at general meetings . consideration, such as shares) . If a company Redeemable shares – Redeemable shares are shares proposes to allot new shares for cash, it is required to which are liable to be redeemed by the company on offer those shares first to the existing shareholders in a specified date or dates or in specified proportion to the shares held by them . However, the circumstances . When a share is redeemed, the pre-emption rights can be disapplied by a special shareholder receives a payment of the amount resolution of the shareholders of the company, or in specified in the articles of association to be payable the case of a private company may be excluded by a on redemption, the shares are cancelled and the provision in the articles of association . company’s share capital is reduced by the nominal amount of the shares redeemed . Maintenance of share capital Convertible shares – Convertible shares are shares One of the basic principles of UK company law is that which are liable to be converted into shares of share capital of the company (including any premium another class . The most common type of paid on it over its nominal value) is regarded as the convertible shares is preference shares which are permanent capital of the company . Subject to certain convertible into ordinary shares . The articles of limited exceptions, once its share capital has been association will set out the circumstances in which issued, it is not possible for the company to reduce the shares convert . its capital or any share premium account or buy back its own shares . The Companies Act provides for Deferred shares – Deferred shares are shares which certain limited exceptions to this rule, including a have no right to vote, to participate in the profits or, reduction of capital procedure . For public companies, except in extreme circumstances, to participate on a the procedure requires a court order but for private winding-up . They normally serve one of two companies a special resolution of shareholders and a purposes . Firstly, if the share capital is being solvency statement from the directors covering a re-organised in such a way that a proportion of the 12 month period are all that is required . The company’s existing share capital is no longer needed Companies Act also permits the purchase by the or relevant, then the surplus shares may be converted company of its own shares (using profits available for into deferred shares . Secondly, deferred shares are distribution or the proceeds of a new issue of shares) sometimes issued which are convertible into ordinary with the approval of shareholders . shares in certain circumstances and are used as, for example, an incentive to management . Transfer of shares Issuing new shares The articles of association of a company can, as part of the description of the rights attaching to particular Directors of a private company with only one class of classes of shares of the company, impose restrictions share capital do not need shareholder authority to on the ability of shareholders to transfer those shares . allot shares of the same class . However, for private In particular, the articles of association of private companies with more than one class of shares and companies often contain pre-emption rights which 14 Regulations and procedures of English HERBERT SMITH FREEHILLS companies – basic company law

Regulations and procedures of English companies – basic company law give the existing shareholders a first right to buy the separated because it may be commercially shares of any shareholder who wishes to transfer convenient for shares to be registered in the name of them . This would not apply in the case of a company a trustee or nominee but actually beneficially owned whose shares are listed on the London Stock Exchange by a different person . The beneficial owner of the because, in order for a class of shares to be listed, the shares, if he is not also the legal owner, therefore has shares must be freely transferable . no special status in relation to the company and only has rights against the legal holder . The articles of RELATIONSHIP BETWEEN THE association may, however, expressly provide for a COMPANY AND ITS SHAREHOLDERS member to nominate another person to exercise all A shareholder’s relationship with the company in or any of his rights on his behalf . which he holds shares is a contractual one . Under the Companies Act, the articles of association bind the There are no restrictions on foreign shareholders, company and its members to the same extent as if except in regulated industries, such as financial they were covenants on the part of the company and services (see Chapter 7 below) . each member to observe the provisions . The articles of association therefore constitute a form of contract MANAGEMENT between the company and its shareholders and Division of powers between the shareholders themselves . The shares Articles usually delegate to the directors the exercise held by the members give a right of participation in the of the powers of the company not required by the company on the terms of the articles of association . articles or the Companies Act to be exercised by the shareholders in general meeting or by A shareholder does not have a proprietary interest in shareholder resolution . the underlying assets of the company . Shareholders are entitled in proportion to their respective Management structure shareholdings to a share of the distributed profits of the company and, on a winding-up, to the surplus Companies have a single-tiered board . Under the assets of the company after the company’s creditors Companies Act, private companies must have at least have been repaid in full . Shareholders are not liable for one director and public companies at least two . the acts of the company, except in certain Subject to this, the articles may prescribe a maximum circumstances when the corporate veil can be pierced . or minimum number of directors . Directors can be executive (with a service contract) or non-executive, The concept of the articles of association as a with varying roles and duties . Corporate directors are contract is subject to the limitation that it is possible permitted, but at least one of the directors must be an for the articles to be amended at any time, or even individual . The minimum age for a company director is completely replaced, with the approval of a special 16 years . There is no maximum age . There are no resolution of the shareholders of the company . restrictions on foreign directors .

The definition of a member of a company is concerned with the legal ownership of the shares, that is the person whose name appears on the register of members . No notice of any trust can be entered on the register of members . The legal and beneficial ownership of shares is, however, frequently HERBERT SMITH FREEHILLS Regulations and procedures of English 15 companies – basic company law

Directors’ duties Directors’ liability The Companies Act includes a statutory statement Directors may be personally liable for, among of the duties a director owes to the company . The other things: statutory directors’ duties are: a breach of their statutory duties under the a duty to act within the powers conferred by the Companies Act; company’s constitution; a breach by the director or the company of a duty to promote the success of the company for requirements or restrictions in the Companies the benefit of the members as a whole; Act; and a duty to exercise independent judgment; fraudulent or wrongful trading if the company becomes insolvent (Insolvency Act 1986) . a duty to exercise reasonable care, skill and diligence; Directors can be disqualified from acting as a a duty to avoid conflicts of interest; director for up to 10 years under the Company Directors Disqualification Act 1986 . a duty not to accept benefits from third parties; and a duty to disclose an interest in a proposed Shareholder approvals transaction with the company . Acts of all shareholders in their capacity as members, whether or not decided on at meetings, The duties apply to all of the directors of a company are regarded as the acts of the company itself . but the statutory statement of duties does not cover all the obligations that a director may owe as a director Annual General Meeting (AGM) of a company . Others are scattered throughout the Companies Act, such as the duty to deliver accounts A public company must hold an AGM within and the obligation to disclose an interest in an existing six months of its financial year-end . Twenty one clear transaction with the company, and in other statutes, days’ notice of the AGM is required, unless all who for example, the Insolvency Act 1986 . are entitled to attend and vote consent to short notice being given . There is no statutory requirement Directors’ transactions for a private company to hold an AGM but there may be an express requirement to hold one in the The Companies Act sets out certain restrictions on company’s articles of association . transactions between a company and its directors, including requiring shareholder approval before General meeting (GM) directors can acquire non-cash assets from the company and prohibiting the company from making Any shareholder meeting other than an AGM is a or guaranteeing a loan to one of its directors without general meeting . Generally the minimum statutory prior shareholder approval subject to notice period required for a general meeting which is certain exceptions . not a public company AGM is 14 clear days . For listed companies, however, the minimum statutory notice period for general meetings other than AGMs is 21 clear days . Listed companies can reduce the minimum notice period for these meetings to 14 clear days if: (i) shareholders have passed an annual 16 Regulations and procedures of English HERBERT SMITH FREEHILLS companies – basic company law

Regulations and procedures of English companies – basic company law resolution to shorten the notice period to 14 clear by the class rights of the shares in question set out in days; and (ii) the company allows shareholders to the articles of association) . The notice must state the appoint a proxy by electronic means via a website . time and place for the meeting and specify the business which is to be conducted at the meeting . Shareholders holding 90% (in the case of private The directors of any company may also convene a companies) or 95% (in the case of public general meeting whenever they think fit . companies) of the nominal value of shares giving a right to attend and vote may agree to shorter notice In addition, under the Companies Act, the members of general meetings . The articles of association may of the company may requisition a meeting by serving specify a longer notice period (but the articles of notice on the directors requiring them to do so . In association cannot specify a shorter period) . order to be valid, a requisition must be executed by members holding at least 5% of the paid-up share Resolutions capital of the company giving a right to vote at There are two types of resolution prescribed by the general meetings . The members of a public company Companies Act: may also require the directors to circulate a notice of an additional resolution that they wish to be put to Ordinary resolution – which requires the consent the members at an AGM . Such a requisition must be of more than 50% of those present and voting . executed by members holding at least 5% of the total Special resolution – which requires the consent of voting rights of all the members having the right to not less than 75% of those present and voting . vote at that AGM or at least 100 members in number and holding shares with an average sum paid up per An ordinary resolution is the most common type of member of at least £100 in nominal value . resolution . Most decisions of the company are made Proceedings at general meetings by ordinary resolution . A special resolution is required (inter alia) to alter the articles or to change The quorum requirement for a general meeting is set the name of the company . All special resolutions by the company’s articles of association . Generally, must be filed at Companies House within 15 days of unless there are special class rights requiring a being passed and the Companies Act specifies member of each class to be present to create a certain ordinary resolutions which are required to be quorate meeting, or the company is a single member filed at Companies House (eg, an ordinary resolution company, the quorum requirement is two members . authorising directors to allot shares) . Under the Companies Act, any member entitled to Under the Companies Act, certain resolutions (eg, to attend and vote at a general meeting may appoint a remove a director) require special notice to be given proxy, who need not be a member, to attend in his to the company . Resolutions requiring special notice place . The members must be informed of their right to are not effective unless notice of the intention to appoint a proxy . When the notice of meeting is sent out move the resolution is given at least 28 days before by the company, a form of proxy will be made available the meeting . to shareholders, which will state that if a shareholder wishes to appoint a proxy, unless the shareholder Calling a general meeting specifies otherwise, the chairman of the meeting will be A general meeting is convened by way of a notice deemed to be the proxy for the shareholder . In order to given by the company to all shareholders entitled to be valid, forms of proxy must be returned at least receive notice of general meeting (this is determined 48 hours before the relevant meeting . HERBERT SMITH FREEHILLS Regulations and procedures of English 17 companies – basic company law

Unless a poll (that is a ballot vote) is demanded, voting new class of shares ranking in priority to the existing on resolutions at general meetings is by way of a show class will constitute a variation of the class rights of of hands . Unless the articles provide otherwise, on a the existing class . show of hands each member present in person and every proxy present who has been duly appointed by a If a separate class meeting is required, the member, has one vote regardless of the number of Companies Act provides that the quorum at the class shares he/the appointing member holds . meeting must be two persons holding, in person or by proxy, at least one-third in nominal value of the The articles of association set out who may demand issued shares of the class in question . However, at an a poll, but the Companies Act contains certain adjourned meeting, this quorum is reduced to one restrictions on what the articles may provide . The person present in person or by proxy . articles cannot provide that a demand for a poll must be made by more than five members (present in Written resolutions of private companies person or by proxy) or by members (present in The Companies Act sets out the procedure for person or by proxy) holding more than 10% of the written resolutions of private companies, as an voting rights . alternative to holding a shareholder meeting . In relation to resolutions required by the 2006 Act, or Equally the articles cannot exclude the right to any other enactment, the Companies Act procedure demand a poll except on election of the chairman of must be used even if the company’s articles contain a the meeting or an adjournment of the meeting . procedure for written resolutions .

On a poll, unless the articles provide otherwise, each The Companies Act provides that a written shareholder present, whether in person or by proxy, resolution can be passed if agreed to by 50% of the has a number of votes equal to the number of shares members for an ordinary resolution and 75% of the held by him . members for a special resolution . Once passed, a written resolution will have the same effect as a Class meetings resolution passed at a general meeting . If a company’s share capital is, or is to be, divided into separate classes of shares then it is possible that a Under the Companies Act, shareholders in a private separate meeting of the holders of the shares of one company may requisition the circulation of a written or more of those classes may be required in addition resolution . The required percentage is 5% of the to a general meeting of all the shareholders . total voting rights of all members entitled to vote on the resolution, or any lower percentage specified in The company will be required to seek the approval of the articles . There is also a right to have a statement the members of a class of shares by way of a of no more than 1,000 words circulated with separate class meeting if the rights attaching to that the resolution . class of shares are to be varied . There may also be additional obligations to call class meetings set out in There are special procedures for certain types of the articles of association of the company . Articles of written resolutions (for example, share buy-backs association will often provide that the creation of a and directors’ service contracts) which are set out in 18 Regulations and procedures of English HERBERT SMITH FREEHILLS companies – basic company law

Regulations and procedures of English companies – basic company law the provision in the Companies Act relating to approval of that matter .

A written resolution is not permitted when using the powers in the Companies Act to remove a director or remove an auditor .

The Companies Act does not permit public companies to use written resolutions . HERBERT SMITH FREEHILLS The differences between a private company 19 and a public company

4. The differences between a private company and a public company The Companies Act imposes certain where a public company allots shares as fully or partly paid in exchange for non-cash consideration, any additional restrictions on public undertaking which forms part of that consideration companies for the protection of (eg, to transfer assets to the company) must be shareholders and creditors . In performed within five years of the allotment and an expert’s valuation and report on the consideration addition, a key difference between a given will usually be required; and public company and a private the original subscribers to the memorandum of a company is that only a public public company must pay for their shares in cash . company may make an offer of its MAINTENANCE OF CAPITAL shares to the public . The principal If at any time the net assets of a public company are benefit, therefore, of setting up a reduced to 50% or less of its called-up share capital, public company is the increased the directors must convene a general meeting within 28 days of the date on which any one of them access to capital through public becomes aware of the fact . The purpose of the issues of securities . The principal meeting is to consider what measures, if any, should differences between private and be taken to deal with the situation – there is no obligation to undertake specific measures . public companies are set out below . DISTRIBUTION OF PROFITS PAYMENT FOR SHARE CAPITAL A company can only pay dividends out of There are a number of detailed rules in the distributable profits . A public company can only Companies Act concerning the payment for shares make a distribution if its net assets do not fall below allotted by companies, most of which relate only to the aggregate of its called-up share capital and public companies: undistributable reserves . The availability of profits is a public company must have an issued share determined by reference to the company’s latest capital of not less than £50,000 (or the Euro statutory accounts . If these do not disclose sufficient equivalent) before it can carry on business as a profits, then special accounts may be drawn up to public company; base the distribution on . a public company may not allot shares unless at LOANS TO DIRECTORS least 25% of the nominal value of the share and the whole of any premium has been paid up; Where a group of companies includes a public company, the rules restricting loans to directors and a public company is prohibited from allotting their connected persons are extended, in relation to shares for consideration other than cash, unless an each company in the group, to credit transactions of expert’s valuation is obtained; a similar nature to loans . a public company is prohibited from accepting an undertaking to do work or perform services as consideration for the allotment of shares; 20 The differences between a private company HERBERT SMITH FREEHILLS and a public company

The differences between a private company and a public company

PURCHASE OF OWN SHARES can choose whether to prepare their individual financial statements in accordance with IFRS or UK Both public and private companies may issue Generally Accepted Accounting Principles (GAAP) . redeemable shares . They may also buy back their Private companies and unlisted public companies own shares in certain circumstances . However, only can choose IFRS or UK GAAP in both or either of a private company can buy back or redeem its shares their individual and group accounts . Companies with out of capital where it has insufficient profits securities traded on AIM (which is an exchange available to fund the buy-back . Purchases by public regulated market but not an EU regulated market) companies must be made out of distributable profits are required to prepare their accounts in accordance or the proceeds of a fresh issue . with IFRS .

Both public and private companies may buy back and OTHER MATTERS then hold and resell their shares rather than cancelling them on a buy-back . Shares held by the Other differences between a public and a private company in this way are held as treasury shares . company include the requirement to have at least two directors for a public company rather than one FINANCIAL ASSISTANCE FOR for a private company, the ability of members of ACQUISITION OF SHARES private companies to agree to written resolutions instead of having resolutions proposed at general A public company cannot give financial assistance meetings, the availability of certain relaxations (including the giving of a guarantee or indemnity or contained in the Companies Act (a number of these the grant of any security over its assets) for the apply only to private companies eg, the ability to purchase of its own shares or the shares of its dispense with an AGM, the ability to carry out a holding company or to discharge a liability incurred capital reduction without going to court) and the for that purchase . Under the Companies Act, a requirement to have, and qualifications required for, private company cannot give financial assistance for the company secretary . the acquisition of shares in a public company that is its holding company . A private company may provide PUBLIC OFFERS OF SECURITY AND financial assistance for the purchase of its own REQUIREMENTS TO PRODUCE A shares, although there are still other factors to PROSPECTUS consider when deciding whether it is able to do so, in particular the common law capital maintenance A private company may not offer its shares or requirements and the duty of the directors to securities to the public . Only a public company may promote the success of the company . do so . The Companies Act contains a broad definition of an offer to the public for this purpose, ACCOUNTING REQUIREMENTS including (subject to certain exemptions, for example for existing shareholders and employees) any offer Public companies cannot take advantage of the that is not a purely domestic concern of those provisions contained in the Companies Act making and receiving it . In addition, the Prospectus permitting small and medium sized companies to file Rules issued by the Financial Conduct Authority short-form accounts with Companies House . Public (FCA) under FSMA require all companies to produce companies that have securities listed on an EU a prospectus on any offer of transferable securities to regulated market must produce their consolidated, the public in the UK, whether listed or not (the or group, accounts in accordance with International definition of an offer to the public for this purpose is Financial Reporting Standards (IFRS) . However, they different to the definition in the Companies Act) . In HERBERT SMITH FREEHILLS The differences between a private company 21 and a public company

addition, a prospectus is required on an admission of securities to trading on a regulated market in the UK, which includes a listing on the London Stock Exchange Main Market (but not an admission of securities to AIM) . The prospectus must be approved by a regulatory authority, which for UK incorporated companies, and certain companies incorporated outside the European Economic Area (EEA) Member States, will be the FCA .

PUBLIC LISTED COMPANIES The Listing, Prospectus, Disclosure and Transparency Rules issued by the FCA and the Admission and Disclosure Standards of the London Stock Exchange set out continuing obligations for companies whose securities are listed on the Official List and traded on the Main Market of the London Stock Exchange . These continuing obligations largely relate to the circumstances in which public announcements are required to be made by the company (for example, any price sensitive information or a decision to pay a dividend), the contents of its annual accounts and half-year results, the form of any circulars sent to its shareholders, publicity regarding dealings by the directors, certain other senior managers and their connected persons in the company’s securities and restrictions on those dealings, and transactions which require publicity or shareholder approval .

In relation to the governance of public listed companies, the UK Corporate Governance Code (the Code) covers a wide-range of issues, such as board composition, the remuneration of directors, the relationship between a company and its auditor . The Code does not have the force of law but public listed companies are required to report annually on their compliance with the Code and explain any extent to which they have not complied . 22 Acquisitions of private companies HERBERT SMITH FREEHILLS

5. A cquisitions of private companies

One likely route to investment in the The main commercial advantage to structuring an acquisition as a share purchase is that continuity of UK will be through direct acquisition the business is preserved . Both before and after of an existing company . The way in completion, the business is carried on by the same which a company is acquired in the company and, as far as the world at large is concerned, no change has taken place . The heading UK generally depends upon whether on the company’s notepaper will probably be the the company is a public or private same except that different directors and/or a company . The usual process for different registered office may be shown . acquiring a UK private company is One point to consider is that a business acquisition described in this section . Chapter 6 may be much more complex than a share acquisition . In a business acquisition, the buyer must ensure that explains how a takeover of a UK the ownership of each asset has been correctly public company is governed . transferred, whereas a share acquisition, reduced to the basics, requires only a share transfer form SHOULD THE BUSINESS OF THE actually to transfer title . COMPANY OR ITS SHARES BE ACQUIRED? There may be other specific (and in some cases, A key question to be asked by a prospective buyer at significant) advantages and disadvantages to a an early stage of the acquisition process is whether it business or share acquisition, including tax structuring, is preferable to acquire the business of the private which should also be considered in each case . company or the shares of that company . The difference is that, in the case of a share purchase, the THE ACQUISITION PROCESS AND DOCUMENTATION ownership of the company as a separate legal entity is acquired, comprising all of its assets and liabilities . Irrespective of whether the acquisition is a business However, in the case of a business acquisition, the or share purchase, there is a common pattern to the buyer selects which individual assets and liabilities of acquisition process . the company it is interested in acquiring . Expressions of interest The main commercial advantage of a business sale is In the early stages, when the prospective buyer and the ability to avoid inheriting the liabilities of the seller have agreed the key terms of the transaction, target business . Even though the buyer will be such as the price, they commonly enter into heads of carrying on a business in succession to the seller agreement . The main provisions of the heads of under the same business name, any debts or other agreement are typically not legally binding but provide liabilities incurred by the seller before the acquisition a checklist for the content of the final documentation of the business by the buyer are not in general and often set out an expected timetable for the automatically transferred to the buyer . In both a acquisition . Sometimes the heads also contain an share sale and a business sale, the buyer can seek to exclusivity agreement, whereby the seller agrees that protect itself by carrying out due diligence and it will not negotiate and/or approach any other obtaining warranties (see below) but the difficulties interested party for a specified period of time to give of successfully recovering for loss or damage must the buyer time to complete the acquisition . A never be underestimated . confidentiality agreement is also either contained in HERBERT SMITH FREEHILLS Acquisitions of private companies 23

the heads of agreement or entered into separately as a documentation, such as resignations of the seller’s precursor to the buyer being given access to the target nominated directors and auditors (in the case of a company’s financial and commercial information for share sale) and board minutes covering a host of the purposes of due diligence . Both the exclusivity administrative details . All of these documents are agreement and confidentiality agreement will be negotiated between the parties and their advisers . binding on the parties . Exchange and completion Due diligence Once the parties have agreed on the terms of the Due diligence is the term used to describe the sale and purchase agreement and other process of a buyer investigating the affairs of the documentation, contracts for the acquisition are target company or business . Commonly, the buyer exchanged between the parties . At this point in time, will employ its lawyers and accountants to review, the buyer and seller are legally bound to proceed respectively, the key contracts of the target for all with the transaction, subject to the satisfaction of aspects of its business (for example, with customers, any conditions . Completion of the transaction, at suppliers, employees and property documentation) which time the legal title to the shares or business and the financial information . The due diligence assets is transferred, may occur simultaneously with process can also be helpful to identify any particular exchange of contracts, or may occur in the future at a tax risk or exposure that the buyer may face after time agreed by the parties . A gap between exchange acquisition . Separately, personnel of the buyer may and completion is often chosen for practical reasons wish to review the documentation from a (for example, the buyer may need time to draw down commercial perspective . The due diligence process funds from its banking facilities or may need to raise can start before heads of agreement are entered into finance on the equity markets) or for regulatory and often lasts up to the point that the final reasons (for example, the acquisition requires agreements are entered into . It runs alongside the competition clearances or the consideration includes seller’s disclosure process which is described below . listed shares which need to be admitted to trading on a regulated stock exchange) . In most cases, the Negotiation of the agreements reason for the gap between exchange and The main documentation for the acquisition of a completion is also a condition to completion taking business or company comprises a sale and purchase place . The sale and purchase agreement will also agreement, known as an SPA (share purchase contain provisions regulating how the business of the agreement) where the shares of the company are target company is conducted whilst the parties are being acquired and a BPA (business purchase waiting for completion to occur . agreement) where it is the business of the company Warranties and disclosure which is being purchased . This agreement contains the key terms of the acquisition, including risk A large section of the sale and purchase agreement protection for the buyer in the form of warranties is comprised of warranties . Warranties are (see below) and restrictions on the seller setting up contractual statements of fact relating to the competing businesses or poaching staff, suppliers condition of the company or business, covering all and customers . There will usually be a disclosure aspects of its affairs, including employees, letter from the seller to the buyer (see below) and a relationships with customers and suppliers, tax tax deed covering the allocation of liability for position, property, intellectual property rights and taxation of the target between the buyer and seller . litigation . Warranties are usually given by the seller, There is also likely to be a range of ancillary but certain types of seller may resist giving 24 Acquisitions of private companies HERBERT SMITH FREEHILLS

Acquisitions of private companies

warranties if, for example, they have not been actively involved in the management of the company or assets .

The warranties have three principal purposes: they provide the buyer with contractual protection so that where a statement about the company or business is untrue, it can sue for breach of warranty and seek to recover damages; they allocate risk between the parties so that the parties agree in the sale and purchase agreement on, for example, who takes the risk of the company’s accounts not having been drawn up in accordance with generally accepted accounting principles (usually the seller) or who takes the risk on a debt owed to the company not being recovered in full (usually the buyer); and they help to flush out information – it is in the seller’s interests to disclose any potential problems because the seller will not usually be liable to the buyer for damages for any matter that it fairly drew to the buyer’s attention in the disclosure letter .

In the disclosure letter the seller discloses any issues that make the warranties untrue so that the buyer is unable to claim for breach of the relevant warranty . The letter usually refers to the relevant warranties in the sale and purchase agreement, stating to what extent each warranty is made inaccurate by the information in the disclosure letter . Often, the underlying documentary evidence of the issues disclosed to the buyer is also referred to in the letter . The seller will usually dedicate plenty of resources to providing the relevant information to the buyer, which the buyer will want to review as part of its due diligence . Consequently, the due diligence and disclosure processes run alongside each other with the parties’ lawyers working closely together until the final agreement is reached . HERBERT SMITH FREEHILLS Takeovers of public companies 25

6. Takeovers of public companies

As mentioned in Chapter 5 above, doubt as to the application of the Takeover Code . The Panel has a range of sanctions available to it for the processes for acquiring a private breach of the Code which include private or public company and a public company in criticism, requiring compensation to be paid to target the UK are not the same . shareholders and requiring FCA authorised persons to refuse to deal with a person who disobeys a Panel ruling . The Panel also has power to require any The acquisition of a public company person to provide information to it and it can apply to in the UK is governed by the Takeover the courts to enforce any of its rulings . Code, enforced by the Takeover Panel . General Principles and Code Rules An explanation of these and a The Takeover Code contains six General Principles for comparison of private and public the good conduct of takeover bids . These include acquisitions is set out below . equality of treatment for target shareholders; providing sufficient information to target shareholders; THE TAKEOVER CODE and the target board being required to act in the interests of the target as a whole . The Takeover Code Application of the Takeover Code also contains detailed rules in a number of areas The rules of the City Code on Takeovers and Mergers including setting out restrictions on, and disclosure of, (the Takeover Code) apply to the acquisition or acquisitions of shares and interests in shares; when a consolidation of control of: compulsory takeover bid has to be made; the timetable for a takeover bid; the terms of the bid; and any public company incorporated in the UK, the contents and circulation requirements of the Channel Islands or Isle of Man which has its shares announcements and documentation produced by the admitted to trading on a UK regulated market bidder and the target . The spirit as well as the letter of (such as the Main Market of the London Stock the Takeover Code must be observed . Exchange), a UK multi-lateral trading facility (such as AIM) or a stock exchange in the Channel Islands Many of the Takeover Code Rules also apply to those or the Isle of Man; or who are deemed to be acting in concert with either any other public incorporated in the UK, Channel the bidder or the target, known as concert parties . Islands or the Isle of Man which has its place of central management and control in one of METHODS OF EFFECTING A TAKEOVER those jurisdictions . OF A UK PUBLIC COMPANY There are two principal ways to effect a takeover of a It is the status of the target that determines whether UK public company . It can either be implemented by or not the Takeover Code applies . a contractual takeover offer by the bidder to acquire the shares of the target (a takeover offer) or by a The Takeover Panel and sanctions court procedure known as a scheme of arrangement for breach (a scheme) . The Takeover Code is drawn up and administered by the Takeover Panel (the Panel) . The Panel has Takeover offer statutory powers to supervise and regulate takeover A takeover effected by an offer involves an offer bids . It must be consulted whenever there is any contract (the offer document) between the bidder 26 Takeovers of public companies HERBERT SMITH FREEHILLS

Takeovers of public companies

and the shareholders of the target including the transfer of shares under an offer . However, which of financial terms, conditions and other offer provisions . the two routes is chosen will depend on a variety of different circumstances . It must be a minimum condition of the offer that sufficient acceptances are received to give the bidder A scheme is not the same as the statutory merger ownership of at least 50% of the target’s voting process which is used in other jurisdictions because shares (this is a Takeover Code requirement) . the target is not removed as a corporate entity in the Normally also (but at the option of the bidder rather process . It remains in existence following the than as a Takeover Code requirement), it will be a takeover, as a subsidiary of the bidder . condition of the offer that a 90% acceptance level is achieved in order to allow the bidder to use the There are a number of tax issues that need to be statutory power in the Companies Act to force considered in the context of takeovers and schemes minority shareholders who have not accepted the of arrangement including (amongst other things) offer to sell their shares on the terms of the offer, so ascertaining whether rollover relief is available . the bidder obtains 100% ownership (this process is known as compulsory acquisition or squeeze out) . THE PRE-BID PROCESS Recommended or hostile bid Scheme of arrangement Most bidders will wish to seek the recommendation A scheme of arrangement is a court procedure under of the target board to the takeover bid . The takeover the Companies Act . The scheme is proposed by the bid is then recommended rather than hostile . Target target company to its shareholders . The target co-operation facilitates due diligence, and reduces prepares and issues the court documentation and a the chance of the target shareholders rejecting the circular to shareholders of the target (scheme bid . The two boards and their advisers would then circular) . The target shareholders are asked to pass negotiate the terms of the bid . resolutions to approve the scheme at a shareholder meeting of the target . The resolutions must be passed Requirement to make an announcement by a majority in number representing 75% in value of of a possible takeover; put up or shut up those voting (excluding any shares already held by the deadlines bidder) . If the resolutions are passed, the court is On a recommended bid, the parties will normally asked to sanction the scheme and the scheme then want to avoid making an announcement until a becomes effective once the court order sanctioning definite decision to make the offer has been made the scheme is delivered to Companies House . The and terms have been agreed, hence the importance scheme is binding on all shareholders, regardless of of absolute secrecy pre-announcement . If there are whether they voted in favour of the scheme . Since all any rumours in the market or there is any unusual shares of a particular class are acquired by the bidder movement in the target’s share price, an immediate under the court order, the squeeze out power used announcement of the possible takeover will be under the offer route is not needed . required by the Panel naming any potential bidders with whom the target is in discussions or from whom Schemes are often used for takeovers recommended an approach has been received . A target may also by the target board . They have the advantage of choose to announce a possible offer at any time it ensuring 100% ownership of the target once considers appropriate and a bidder is unable to approved and can usually save the stamp duty which prevent it from doing so . is payable (at 0 .5% of the consideration) on a HERBERT SMITH FREEHILLS Takeovers of public companies 27

The first announcement of a bid or possible bid starts announcement) contains details of the principal the offer period, which runs until the offer has terms of the bid and the conditions to which it will be become unconditional as to acceptances (or the subject . The financing for the bid must also be fully scheme has become effective) or the offer (or committed at the time of the announcement . Once scheme) has lapsed . One of the key consequences of the bidder has formally announced a bid, it must, being in an offer period is that the bidder, target and normally within 28 days, post an offer document/ holders of more than a 1% interest in the target (or scheme circular to the target shareholders . Once a bidder in the case of a securities exchange offer) takeover bid is formally announced, the bidder is must disclose their interests to the market and any committed to proceed and the scope to withdraw dealings in target shares (and, on a securities based on the conditions to the bid is very limited and exchange offer, the bidder’s shares) . These are requires the consent of the Panel . known as Rule 8 disclosures . Target board reaction and defensive When an announcement of a possible takeover bid is measures by the target made, there is an automatic 28 day deadline by The target board must decide whether to recommend which a potential bidder must clarify his intentions the takeover bid or reject it . It must set out its opinion and either announce a firm intention to make a on the offer, and the reasons for its opinion, to takeover bid or make a no intention to bid statement shareholders . The target board must also consider (referred to as a put up or shut up deadline) . This their duties under the Companies Act and, in deadline can only be extended with the consent of particular, whether the takeover would be most likely the Panel at the target’s request . If a bidder to promote the success of the company for the benefit announces at the end of this period that it does not of its members as a whole taking into account the list intend to make an offer, it will (except in limited of factors set out in the Companies Act including the circumstances) be prevented from bidding for the environment, employees and the community . target for six months . The target board is also required under the Takeover Due diligence Code to act in the interests of the company as a A bidder is usually unable to carry out the detailed due whole and not to deny the shareholders the diligence exercise that it would carry out for a private opportunity to decide on the merits of a bid . The company or business acquisition because a UK public target board must also obtain independent advice on company will be concerned about releasing confidential any takeover bid from a financial adviser and make information (particularly because, if a rival bidder that advice known to shareholders . emerges, it will, on request, be obliged to provide the same information to that rival) . On a hostile bid, the If the target board does not recommend the takeover bidder has to rely solely on public information about the bid and so the bid is hostile, the target board will target to carry out its due diligence exercise . publish a defence document outlining the reasons for its recommendation to shareholders to reject the bid . MAKING AN OFFER The Takeover Code contains specific provisions to Announcement of firm intention to make prevent the target board from taking any action a takeover bid – bidder’s commitment to without shareholder consent which might frustrate proceed with a takeover the bid or deny shareholders the opportunity to decide on its merits . The formal announcement of a firm intention to make a bid (also referred to as a Rule 2 7. 28 Takeovers of public companies HERBERT SMITH FREEHILLS

Takeovers of public companies

There is a general prohibition in the Takeover Code of the EU Prospectus Directive will need to be issued on deal protection arrangements entered into unless an exemption applies . between the bidder and the target . This includes break fees or inducement fees (that is, fees payable The bidder will need to know how many options over by the target to the bidder if the bid fails) . There are unissued target shares are outstanding (whether for limited exceptions for, amongst other things, employees or third parties) and whether the target confidentiality agreements and commitments to has issued any securities which are convertible into assist with obtaining regulatory clearances . voting shares . The bidder is required to make appropriate proposals to option holders and holders Employees and pension scheme trustees of convertible securities in the target . Employee representatives and the trustees of the RESTRICTIONS ON SHARE target’s pension schemes have specific rights under ACQUISITIONS BEFORE AND DURING the Takeover Code to receive information about the A TAKEOVER offer and to have their views published, irrespective of where they are located . The bidder must disclose A number of provisions in the Takeover Code restrict its intentions as regards the target’s employee and the parties to the bid from dealing in target (and pension schemes . Where the target has employees bidder) shares . Further when a party does deal in within the EU, consultation obligations may also (but shares, there may be consequences to that dealing . do not always) arise in relation to either or both of the The table below sets out the key thresholds and the prospective offer and the possibility of job losses . implications of dealing .

Choice of consideration for the bid All shareholders must be treated equally in relation to the consideration being offered . If any special deals are made with favourable conditions with any shareholders (eg, on a management buy-out where managers are to receive interests in the bidding vehicle where other shareholders will not), the arrangements must be approved by a vote of independent target shareholders .

Generally, the bidder is free to choose what type of consideration it offers . However, acquisitions of interests in target shares by the bidder will change this position . The effect of acquisitions on the level and type of consideration which must be made available is set out in the table on significant shareholder levels in the “Restrictions on share acquisitions” section below . If the bidder is proposing to offer securities as consideration, the documentation must contain additional information and a prospectus complying with the requirements HERBERT SMITH FREEHILLS Takeovers of public companies 29

Significant shareholder levels Leve Significance Level Significance 1% If a party owns, or has interests in, more than 1% of the shares of the target (or bidder, unless the offer is for cash only) at the start of an offer period (or reaches that threshold while a company is in an offer period), he must disclose his interests to the market, at the start of the offer period (or when he reaches/exceeds the 1% threshold) and disclose all dealings in shares or interest in shares of the target (or bidder as the case may be) . 3% Any person whose interest in the voting rights of a UK company listed on the Official List, another EEA regulated market, or AIM reaches, exceeds or falls below 3% (or any percentage point over 3%) must notify the company, which must notify the market . 10% If a bidder (including parties acting in concert) has acquired interests in more than 10% of the target’s shares for cash within 12 months before a takeover bid (or possible bid) is announced, it must offer a cash alternative to all shareholders at not less than the highest price paid . If it (including parties acting in concert) acquires interests in more than 10% of the target’s shares in exchange for securities in the three months before a takeover bid is announced it must offer securities as consideration . 29 9%. No person (including parties acting in concert) may acquire shares or interests in shares which would take his interests in the shares to 30% or more of the voting rights (except in certain limited circumstances) . 29 9%. is the maximum interest in target shares which a person (with his concert parties) may have without being obliged to make a mandatory cash bid (see below) .

When a mandatory or Rule 9 bid Effect of market purchases on ability to is required secure full control of target No person, or group of persons acting in concert, can Market purchases enable a bidder to build up a stake acquire an interest in shares of a UK public company in the target but this does not always make it easier carrying 30% or more of the voting rights without to obtain 100% control over the target . In particular, triggering an obligation to make a general takeover any share purchases prior to the despatch of the offer bid to acquire the remainder of the shares: a document are not allowed to be counted towards the mandatory offer, or a Rule 9 offer . A mandatory bid 90% acceptance level required in order to acquire must only have a 50% acceptance condition and compulsorily the outstanding minority shares in a normally no other conditions will be permitted . In takeover by contractual offer (see above) . If a addition, the mandatory bid must be in cash (or scheme of arrangement is being used then any include a full cash alternative) at a value not less than shares purchased by the bidder, whether before or the highest price paid by the bidder for any interest in after the scheme document is posted, cannot be shares during the offer period and in the 12 months voted in favour of the scheme . prior to its commencement . 30 Takeovers of public companies HERBERT SMITH FREEHILLS

Takeovers of public companies

OBTAINING CONTROL OF THE TARGET Irrevocable undertakings and letters of intent Takeovers effected by an offer The bidder will want to obtain irrevocable In order to obtain control of the target company, the undertakings to accept the takeover bid from some bidder will need to receive acceptances in relation to of the shareholders in the target before it announces shares which, when added to any shares that the the bid . There are restrictions on obtaining bidder has already acquired, amount to more than irrevocable undertakings over more than 30% of the 50% of the voting shares of the target company . voting share capital of the target unless the bid Once the bidder has more than 50% of the voting is recommended . shares of the target it will have the power to remove the directors of the board of the target .

Most bidders will be aiming to receive acceptances in respect of at least 90% of the voting share capital of the target not already owned by the bidder when it makes the offer . This is because it will then be entitled to compulsorily acquire, that is squeeze out, any outstanding shares from those minority shareholders who have not accepted the offer .

Takeovers effected by scheme of arrangement The scheme must be approved at a meeting of the shareholders of the target by a majority in number representing 75% in value of those voting . Once the resolutions are passed, then court approval is sought for the scheme . Court approval is normally a formality . However, there is always a right for a target shareholder or creditor to raise technical or fairness objections to the scheme . Once the court has sanctioned the scheme, the court order is delivered to Companies House and the scheme becomes binding (and the bidder acquires 100% control of the target) at that stage . HERBERT SMITH FREEHILLS Takeovers of public companies 31

CONTRAST WITH THE ACQUISITION OF A PRIVATE COMPANY A public takeover bid in the UK has a very different structure to a UK private acquisition . The table below highlights the key differences .

Private acq Private acquisition Takeover offer or scheme Bidder usually negotiates with target shareholders Bidder negotiates with target board

Must be agreed Can be recommended or hostile

Terms based on acquisition agreement Terms based on offer document/scheme circular

Terms negotiated between parties Price set by bidder (with target board if recommended) . Other terms determined by Takeover Code

Financial adviser not required Both bidder and target need a financial adviser

Extensive warranties from target shareholders Generally no warranties

Extensive due diligence by bidder Restricted due diligence by bidder

100% acquisition assured provided conditions are Risk of not obtaining sufficient acceptances: satisfied takeover by contractual offer could lapse could have outstanding minority if do not reach 90% acceptance level on a contractual offer scheme may not be approved by requisite majority of target shareholders

Usually completed within a four/six week timetable Offer period could continue for up to three months after initial announcement of bid

TAX There are a number of tax structuring issues that need to be considered when planning a takeover, for example, it may be possible to structure a takeover so irrecoverable VAT is minimised . 32 Restrictions on acquiring regulated businesses HERBERT SMITH FREEHILLS

7. Restrictions on acquiring regulated businesses There are specific rules governing requirements apply to authorised and unauthorised entities alike . acquisitions of companies operating in regulated business areas, such as Requirement to notify/obtain approval financial services, banking, media, Section 178(1) and 191(D)(1) of FSMA require a broadcasting, telecoms, energy and person (whether or not he is an authorised person) to notify the appropriate regulator if he decides to utilities . Some of the regulatory acquire, increase or reduce control or to cease to obstacles that an investor might have control in a UK authorised firm . Failing to notify the appropriate regulator is an offence which encounter in a number of these areas may result in an unlimited fine being imposed . are set out below . A person is deemed to acquire control over a UK FINANCIAL SERVICES ENTITIES authorised person if he holds 10% or more of the AUTHORISED UNDER THE FINANCIAL shares or voting power in the UK authorised SERVICES AND MARKETS ACT 2000 person (or its parent undertaking) or if his (INCLUDING BANKING, INSURANCE, shareholding or voting power results in him being INVESTMENT SERVICES) able to exercise significant influence over the Background management of the UK authorised person . In the UK, restrictions which apply to the If an existing controller increases his control over a acquisition of interests in firms authorised under UK authorised person (or its parent undertaking) the Financial Services and Markets Act 2000 and crosses the notification thresholds at 20%, (FSMA) to carry on banking, insurance or 30% or 50% this will trigger the requirements to investment services business reflect the notify the appropriate regulator . requirements of the EU Acquisitions Directive Notice must be in writing and include such (Directive 2007/44/EC) . information and be accompanied by any such The requirements can be found in: documentation as the appropriate regulator may reasonably require (section 179 of FSMA) . Part XII of FSMA and relevant subordinate legislation; and A person who intends to acquire control or increase its control over a UK authorised firm in 2 the appropriate regulator’s Handbook of Rules any of the ways described above is required to and Guidance including, in particular, Chapter 11 obtain the appropriate regulator’s approval before of the Supervision manual (SUP 11) . doing so . FSMA change of control provisions impose a range The application of the above requirements has of obligations upon persons who are either been modified in respect of certain authorised proposing to become controllers of UK authorised firms, including insurance intermediaries and firms or are already controllers of UK authorised building societies . firms . The regulatory status of the proposed or actual controllers is not relevant and the

2 The appropriate regulator is the Prudential Regulation Authority (PRA) or the Financial Conduct Authority (FCA), depending on whether the business is a PRA-authorised firm or a FCA-authorised firm. HERBERT SMITH FREEHILLS Restrictions on acquiring regulated businesses 33

PUBLIC PROCUREMENT EU . Among other measures, the reform proposals include adopting a single EU notification and The EU procurement rules, as implemented through authorisation regime, requiring a communications UK regulations, govern the way in which public provider to submit a single notification in the country bodies and certain regulated utility businesses place in which it is established which will apply in all other their contracts for supplies and services . The Member States in which it operates . If the reform regulations apply, for example, to water companies, proposal is adopted (currently scheduled for the electricity distributors, railway and airport operators . latter half of 2014) this would therefore represent an These regulations do not apply to the acquisition of additional obligation in the UK . the regulated business itself, but will have an ongoing impact on the way in which such a business chooses Companies providing television or radio services its suppliers and contractors . They may, for example, require a licence from Ofcom . These licences limit the extent to which the regulated business can generally require the licensee to notify Ofcom in award contracts directly to its affiliates or parent relation to a change of control or a change of company, without first advertising those contracts shareholding above a certain threshold . There are and calling for competition . also a number of general disqualifications in the TELECOMS, MEDIA AND relevant legislation restricting certain classes of BROADCASTING people from holding broadcast licences . In addition, certain bodies (such as political bodies) are subject The provision of telecoms, media, internet and to qualified restrictions on their ability to acquire broadcasting networks and services (referred to as licences . Media ownership rules also provide for electronic communications networks and services) and limits on cross-media ownership . These media television and radio services are regulated in the UK by ownership rules were significantly relaxed in 2011 the UK national authority regulator for communications, and are currently the subject of a wide review that the Office of Communications (Ofcom) . will inform the commissioning of a media plurality measurement framework as part of the first analysis Companies providing electronic communications of media ownership and plurality in the UK . networks and services do not require licences to provide their networks or services (unless they use Ofcom also has concurrent powers with the radio frequency spectrum to provide wireless Competition and Markets Authority (CMA) to services) . They are instead subject to a general enforce competition law in the communications authorisation regime and, in certain circumstances, sector . From April 2014, Ofcom has been subject to a specific additional conditions imposed by Ofcom on duty to consider using its competition law powers a particular party (such as price controls imposed on before using its regulatory powers . For transactions operators with significant market power) . The within the communications sector which fall within general authorisation regime does not, however, the scope of the UK merger control regime, the CMA require regulatory approval for a change of control . will usually consult Ofcom in relation to the transaction (for example before approving a In September 2013, the European Commission transaction or referring it for an in-depth Phase 2 published the “Connected Continent” legislative investigation) . Media mergers may also be referred package to reform the EU telecommunications for an in depth Phase 2 CMA investigation by the regulatory framework promoting a single EU Secretary of State on the basis of specified public telecoms market by removing barriers within the interest considerations . market and developing harmonised rules across the 34 Restrictions on acquiring regulated businesses HERBERT SMITH FREEHILLS

Restrictions on acquiring regulated businesses

The Authority for Television On-Demand (ATVOD) country, Ofgem must notify the Secretary of State of is a co-regulatory body responsible for regulating the the UK Government and the European Commission . editorial content of “on-demand programme services”, with Ofcom retaining legislative “back Where the Secretary of State submits a report, or the stop” powers . Unlike regulation of linear European Commission submits an opinion, to Ofgem broadcasting, on-demand media service providers stating that security of electricity supplies in the UK or are not required to apply for a licence . The regulatory any other EEA state would be put at risk if the regime requires that such providers notify ATVOD of application were to be certified, Ofgem has to take the service before it is launched and comply with utmost account of the relevant opinion and would statutory rules . The regulatory regime does not refuse certification . Similarly, where a person from a require regulatory approval for a change of control . third country has taken, or may take, control of a certified electricity or gas transmission or ENERGY interconnection licensee, Ofgem must notify the Companies involved in the generation, supply, Secretary of State and the European Commission and transmission or distribution of electricity, or the supply, assess whether the certification criteria, including that shipping, distribution or transmission of gas onshore in which ensures the security of electricity supply of the Great Britain, or the operation of an interconnector UK and other EEA states, continue to be met . require a licence from the Office of Gas and Electricity Markets (Ofgem) . Licences, particularly for companies Ofgem also has concurrent powers with the CMA to carrying out monopoly activities, are likely to include enforce the Competition Act 1998 and Articles 101 conditions that are triggered by a change of control or and 102 of the Treaty on the Functioning of the corporate restructuring, such as a requirement for European Union in the electricity and gas sector . The certain undertakings to be given by the licensed CMA was established under the Enterprise and company’s ultimate controller and the requirement to Regulatory Reform Act 2013 and became fully hold an investment grade credit rating . Other conditions operational on 1 April 2014, replacing the Office of Fair may impact on a proposed acquisition, such as Trading and the Competition Commission . In the restrictions on asset disposal and granting security, event of merger activity, Ofgem remains responsible financial ring fencing obligations, and prohibitions on for advising the CMA who may then approve a merger cross-subsidy . or acquisition or refer it for a more in depth (Phase 2) investigation . Although there is no current specific UK Legislative changes made in November 2011 to fully merger legislation relating to the electricity and gas transpose the ownership unbundling requirements of sector (in contrast to the water sector), changes in the EU Third Energy Package, applicable to gas and ownership may require the modification of existing electricity transmission system operators and licence conditions or give rise to other issues within operators of gas and electricity interconnectors, Ofgem’s jurisdiction . As a result, Ofgem may issue a could affect the ability of foreign investors to acquire consultation on the impact a merger or acquisition a controlling stake in such companies . The legislative may have on competition in the energy market before changes require holders of electricity transmission deciding on the advice it would offer the CMA . Ofgem and interconnection licences to be certified by may also advise the European Commission if a merger Ofgem . With effect from 3 March 2013, where a may impact the European energy market . certification application is made by a person from a third country (ie, a country that is not part of the Investors should note that, on 26 June 2014, Ofgem EEA), or a person controlled by a person from a third referred the energy market to the CMA for a full investigation . This investigation is to start immediately HERBERT SMITH FREEHILLS Restrictions on acquiring regulated businesses 35

and the CMA is expected to publish its final decisions The Scottish Government is also supportive of the by the end of 2015 . The CMA can decide which areas to reform proposed by the Wood Review . However, the include in its investigation; however Ofgem expects that referendum for an independent Scotland in these will include: the relationship between the September 2014 may, in the event of Scotland voting generation and supply businesses of the six largest to leave the Union (current polls indicate that this is electricity suppliers (known as the “big six”); barriers to unlikely), lead to heavy negotiation over the suppliers entering and expanding into the market; ownership and control of the UKCS . competition between the big six; the profitability of the big six; the perceived trend that consumers who do not Looking forward: UK power industry switch suppliers are given higher prices; and low Potential investors in the electricity sector should consumer engagement . Investors should monitor the keep up to date with progress regarding the progress and outcome of this investigation . implementation of the UK Government’s Electricity Market Reform programme (EMR), which seeks to Different requirements apply to companies carrying promote the development of low carbon electricity out offshore oil and gas exploration or production generation capacity . activities, for which the regulator is the Department of Energy and Climate Change (DECC) . While DECC The EMR comprises: consent is not usually required for a change of control per se, certain structural changes could trigger a a large scale feed-in tariff in the form of a contract revocation, for example if the licensee ceases to have for difference (CfD) for low carbon plant (to sit its central management and control in the UK . alongside and eventually replace the Renewables Obligation (RO) scheme, the existing financial The Energy Act 2008 introduced further support mechanism for renewable requirements for licensing, including for the offshore electricity generation); storage of natural gas and carbon dioxide, and a capacity market, taking in both generation and additional requirements relating to the funding of demand side response; decommissioning of offshore renewables and nuclear energy installations . a floor price for carbon; and an emissions performance standard for the power Looking forward: UK oil and gas industry sector which effectively rules out new unabated The UK Government is taking steps to maximise its coal fired plant . economic returns from the hydrocarbons in the United Kingdom Continental Shelf (UKCS) . On 24 Much of EMR is contained within the Energy Act February 2014, Sir Ian Wood published his report on 2013, which came into force on 18 December 2013 how best to achieve this goal . The report focuses on (with most key parts of the Act taking effect the development of a strong new independent immediately or subsequently in early 2014) . This has regulator that will ensure that both the UK been followed by publication of generic CfD standard Government and industry get the maximum financial terms and conditions, a final Delivery Plan and benefit from the estimated remaining 12 to 24 billion associated documents, bringing the EMR plans barrels of oil in the UKCS . The UK Government and closer to fruition . Most of the detail concerning the opposition parties have committed to implementing institutional framework for delivering EMR is the recommended policy changes, but detail is not contained in secondary legislation that was laid expected until the Budget 2015 . before Parliament on 23 June 2014 . Investors need to 36 Restrictions on acquiring regulated businesses HERBERT SMITH FREEHILLS

Restrictions on acquiring regulated businesses

give detailed consideration to the developing low carbon electricity are awarded certificates that framework for the funding of renewable generation, generators of high carbon electricity are obliged nuclear power and carbon capture and storage to purchase . projects before making investment decisions . There are five principal differences between the CfD The UK Government is seeking to provide increased and the RO . Firstly, the RO is a creature of statute and revenue certainty to low-carbon generation (ie, the CfD is a private law contract reliant on statute to renewables, nuclear and fossil fuel plant fitted with ensure payment via the Supplier Obligation . Secondly, carbon capture and storage technology) through the the RO is paid on top of market prices whereas the use of CfDs . CfDs are not a new feature of the UK CfD gives a fixed income set at the strike price power market; they were used extensively under the determined for a given technology . Thirdly, the RO Electricity Pool (the trading arrangements in place creates an incentive to buy renewable power, whereas prior to the privatisation of the electricity sector), and under the CfD the renewable generators are fully to support nuclear and renewable plant under the reliant on the market to buy their power and therefore Non-Fossil Fuel Obligation regime . trigger payment of the strike price . Fourthly, under the RO if the project satisfies the criteria it is eligible for the Under the EMR CfD arrangements, low-carbon full level of support . However, under the CfD, certain generators will enter into long term contracts which are technologies will be subject to competitive allocation based on a fixed strike price (being a price per unit of which may drive the strike price down therefore electricity set at a level determined to be necessary to affecting the viability of any given project . Finally, support the relevant generation technology) and which under the RO penalties levied at projects were refer to an agreed market reference price (being the graduated and therefore proportionate, ranging from approximate value the generator could be expected to revocation of issued Renewables Obligation receive when it sells its power in the wholesale Certificates (ROCs) to loss of authorisation . Under the electricity market) . Assuming that generators can sell CfD the primary penalty is termination . power in the wholesale energy market at the market reference price, the CfD mechanism compensates For the first three years of operation, the CfDs will sit generators for the difference between the strike price alongside the RO with developers being free to and the market reference price (when the market choose between them until 31 March 2017 . A project reference price is lower than the strike price) . However, cannot benefit from a mix of the two schemes; if the market reference price is higher than the strike however, where a project is constructed in distinct price, the CfD counterparty will require the generator phases, each different phase can be supported by a to pay the difference back . If there is a negative market different mechanism therefore leading to the project reference price (ie, it falls below zero) the generator will as whole benefitting from both ROs and CfDs . only receive the difference between the strike price and zero . It is intended that a stable revenue level should, in Commentators have noted that, given the projected turn, reduce investment risks and financing costs, and increases in electricity prices, financial returns over so drive innovation and development of low-carbon the life of the schemes may be higher for projects technologies . under the RO as opposed to the CfD .

The CfD scheme is a replacement for the existing RO CfD strike prices will initially be set administratively by scheme which is gradually being phased out . The RO the UK Government (as published in the EMR delivery is a certificate scheme through which generators of plan on 19 December 2013) . Competitive price setting HERBERT SMITH FREEHILLS Restrictions on acquiring regulated businesses 37

will be used for some technologies for the first round The UK Government has published its response to of CfDs, in which case the published strike prices will the December 2013 consultation on the generic CfD form the maximum strike price for that technology . together with a Policy and Drafting Update and the form of the generic CfD that will be offered by the The CfDs are intended eventually to be largely CfD counterparty to eligible renewables generators standardised across technologies in order to provide (structured as a front end agreement with a stable base for investment, simplifying the process project-specific provisions incorporating a set of of CfD allocation, and making it easier to compare standard terms and conditions) . It has acknowledged costs of different technologies . In its recent that there may need to be a degree of variation in consultation response on CfD allocation, the UK CfDs for some technologies to reflect whether the Government has broadly grouped technologies into generation is intermittent or baseload, and to two categories: “Group 1” (Established technologies) recognise the different risk profiles of some projects and “Group 2” (Less Established technologies) . It is or technologies . Some technology specific provisions unclear how the Government will classify those will be included in the CfD, and “minor and technologies that currently outside the existing necessary” amendments can be agreed with groups . It is likely that some further groups may be individual generators (but will be published), subject added, but until this is done, we have classified them to rules to be set out in regulations . as “Other” in the table below . The UK Government may initially release only part of The Government has proposed different CfD the CfD budget to avoid overspending . Details will be arrangements for each category . Group 1 released in summer 2014 after a period of technologies will use a generic form of CfD and will consultation with the developers, aimed at assessing be subject to competitive allocation through an whether they intend to apply under the RO or CfD . auction . Group 2 technologies will also use a generic The UK Government intends to announce the RO form of CfD but will be subject to non-competitive rate for 2015/16 in October 2014 . To minimise the allocation unless the relevant budgetary threshold risk of uncertainty, the Government intends to (yet to be set) is exceeded, in which case allocation engage with industry to produce an indicative CfD will move to competitive auction . It is likely that CfDs budget in July 2014 and both the final RO rate and for “other” technologies will be individually CfD budget will be confirmed in autumn 2014 . negotiated and subject to bespoke CfD agreements .

group 1 (established) Group 2 (Less Established) other onshore wind larger than 5MW offshore wind nuclear solar p v. larger than 5MW wave biomass conversion waste with CHP tidal stream CCS hydro projects which are advanced conversion technology large hydro greater than 5MW but less anaerobic digestion tidal than 50MW dedicated biomass with CHP Scottish island onshore wind landfill gas geothermal 38 Restrictions on acquiring regulated businesses HERBERT SMITH FREEHILLS

Restrictions on acquiring regulated businesses

The UK Government is introducing a capacity market WATER with rules intended to ensure that capacity providers Companies that hold an appointment as a water or can demonstrate, through financial collateral or water and sewerage undertaker will be subject to physical backing, that they can deliver the capacity detailed conditions within the terms of their they have agreed to provide . Capacity “agreements” appointment, which are regulated by the Water will be awarded through a competitive central Services Regulation Authority (Ofwat) . The terms of auction in which it is envisaged that both generators appointment will include conditions that may be and non-generation providers of capacity (for relevant to an acquisition, such as conditions example “Demand Side Response”) will be able to concerning: the imposition of price limits; the participate . The first auction is expected to run in maintenance of an investment grade credit rating; December 2014 for delivery of capacity from winter restrictions on asset disposal and the granting of of 2018 . security; financial ring fencing obligations and corporate governance; prohibitions on cross-subsidy; The Energy Act sets a statutory limit on the amount and restrictions on intra group transactions and on of annual CO2 emissions allowed from new fossil fuel incurring cross default obligations . There is also likely power stations at or over 50MW electrical capacity, to be a condition requiring the giving of parent equivalent to 450g/kWh . The annual total tonnage company undertakings, and there may additionally allowance of a plant, calculated by a formula set out be a cash lock-up provision . in the Energy Act, will be based on its installed generating capacity . Unlike the electricity and gas sectors, there is also a requirement, contained in the Water Industry Act The carbon price floor (CPF) is intended to provide 1991, for the CMA to make a mandatory reference an incentive to invest in low-carbon generation . The for a Phase 2 investigation in relation to mergers CPF is a tax on fossil fuels used to generate electricity between water and/or water and sewerage and is administered by HMRC . Under the Finance companies (subject to a turnover threshold) . This Act 2011, existing exemptions from the levy for duty to refer will be subject to certain exceptions electricity generators were removed from supplies of once new legislation which became law in May 2014 fossil fuels such as gas or coal on 1 April 2013 . Such comes into force . The CMA is required to determine supplies will become subject to the levy at the whether the merger may be expected to prejudice relevant carbon price support rate, determined by the ability of Ofwat, in carrying out its functions, to reference to the carbon content of the fuel . Similarly, make comparisons between water/sewerage for generators using oil the level of fuel duty undertakers (eg, in relation to price control) . reclaimable will be reduced by an amount equivalent However, even if Ofwat’s functions are inhibited by to the carbon price support rate . As part of the the proposed merger, the CMA may permit the Budget 2014, UK Government has recently indicated merger to proceed if it considers that the benefits to that the carbon price support rate will be capped at a customers are substantially more important than the maximum of £18 from 2016/17 until 2019/20 . prejudice concerned . Like Ofgem, Ofwat shares concurrent powers with the CMA to enforce the As well as monitoring further development of detail Competition Act 1998 and Articles 101 and 102 of the in the EMR programme, investors should note that Treaty on the functioning of the European Union in many of the EMR arrangements are subject to EU the water sector . State aid approval . HERBERT SMITH FREEHILLS Restrictions on acquiring regulated businesses 39

Proposals for significant changes to the regulatory regime governing water/sewerage companies have been made by Ofwat and by the UK Government . Certain of those changes will be implemented by a new Water Act which became law in May 2014 . 40 Financial services regulation HERBERT SMITH FREEHILLS

8. Financial services regulation

The providers of financial services in day-to-day supervision of banks, building societies, insurers and certain systemically important the UK, whether based in the UK or investment firms . Firms that fall within the abroad, are heavily regulated by a regulatory scope of the PRA are known as combination of UK and EU law, as PRA-authorised firms, or as “dual-regulated firms”, as the FCA is their conduct regulator . explained further below . There are The FCA is a separate institution and not part of also regulatory restrictions on the the Bank of England . The FCA is responsible for acquisition of regulated financial promoting effective competition, ensuring that services providers in the banking, relevant markets function well, and for the conduct regulation of all financial services firms . This insurance and investment sectors includes acting to prevent market abuse and (see Chapter 7 above) . ensuring that consumers get a fair deal from financial firms . The FCA operates the prudential STRUCTURE OF CURRENT regulation of those financial services firms not REGULATORY ENVIRONMENT supervised by the PRA, such as asset managers The PRA and FCA and independent financial advisers . The Financial Services and Markets Act 2000 Both the PRA and the FCA have their own 3 (FSMA) provides the framework for the UK Handbooks which contain rules and guidance for regulatory regime; it is the principal piece of authorised firms . legislation governing the establishment, supervision The UK Listing Authority (UKLA) forms part of the and regulation of financial services in the UK . In FCA . The UKLA is responsible for approving listing addition to the FSMA, there is a substantial amount documents when securities are admitted to listing of secondary legislation implementing the FSMA on the London Stock Exchange, and monitoring including the Financial Services and Markets Act and enforcing compliance by listed companies with 2000 (Regulated Activities) Order 2001 and the continuing disclosure obligations in the Listing, Financial Services and Markets Act 2000 (Financial Prospectus and Disclosure Rules . Promotion) Order 2005 . Other relevant authorities Prior to 1 April 2013, the Financial Services Authority (FSA) was the regulator of financial The Bank of England took over the FSA’s services in the UK . The FSA has since been responsibilities for the supervision of financial replaced, the majority of its functions having been market infrastructures (including recognised transferred to two separate regulators: the payment systems, securities settlement systems Prudential Regulation Authority (PRA) and the and central counterparties) on 1 April 2013 . Financial Conduct Authority (FCA) . The Financial Policy Committee (FPC) was The PRA is a part of the Bank of England . The PRA established on a permanent basis at the same works alongside the FCA creating a “twin peaks” time . The FPC sits within the Bank of England and regulatory structure in the UK . The PRA is is responsible for macro-prudential regulation and responsible for the prudential regulation and maintaining financial stability . It has the power to

3 The PRA is also in the process of putting together its own Rulebook. HERBERT SMITH FREEHILLS Financial services regulation 41

require the FCA and PRA to implement Breach of the general prohibition is a criminal macro-economic tools as it directs . offence and agreements entered into as a result of carrying on the activities are voidable at the In addition to its supervisory responsibilities, the discretion of the courts . Bank of England, as the UK’s central bank, has many other duties, including managing interest Individuals carrying on key roles (known as rate policies as well as the UK’s foreign exchange controlled functions) within an authorised firm and gold reserves . (and in some cases, the authorised firm’s unregulated parent undertaking) are required to HM Treasury is the government department become approved persons . The appropriate responsible for formulating and putting into effect regulator must give its approval before such the UK Government’s financial and economic policy . individuals may carry on the controlled function The Takeover Panel draws up, administers, (eg, act as a director) . interprets and enforces the rules of the City Code on Takeovers and Mergers (the Takeover Code) Financial promotions which apply to the acquisition or consolidation of Section 21 of FSMA provides that a person must control of public companies incorporated in the UK not in the course of business communicate an (see Chapter 6 above) . invitation or inducement to engage in investment The London Stock Exchange and other Recognised activity unless: Investment Exchanges make and enforce rules in he/she is an authorised person; relation to the conduct of business on their markets . he/she is an unauthorised person and the AUTHORISATION AND LICENSING content of the communication is approved for Authorisation regime the purposes of the section by an authorised person; or The general prohibition within section 19 of FSMA prevents any person from carrying on a regulated he/she is an unauthorised person but the activity in the United Kingdom unless he is financial promotion benefits from an exemption . authorised or is an exempt person . A breach of section 21 of FSMA is a criminal Regulated activities include accepting deposits, offence and may render the relevant investment dealing in investments as principal/agent, agreement unenforceable . Firms promoting arranging deals in/managing and advising on investment services or products in the UK must investments, and effecting contracts of therefore consider carefully the application of the insurance . section 21 restriction and any relevant exemptions which may apply . Investments include deposits, shares, government securities, options, futures, and contracts Exemptions from section 21 of FSMA are found in for differences . the Financial Services and Markets Act 2000 (Financial Promotions) Order 2005 . Examples of The full list of regulated activities and investments exemptions include where an approach is made to: is set out in the Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 . an investment professional (which would include any authorised firm); 42 Financial services regulation HERBERT SMITH FREEHILLS

Financial services regulation

a high net worth company; Civil a certified high net worth individual or Market abuse is defined in section 118 FSMA and self-certified sophisticated investor, if the covers insider dealing, improper disclosure, misuse promotion relates to an investment in an unlisted of information, trading which gives a false or company or a fund which invests wholly or misleading impression as to the supply, demand or predominantly in unlisted companies; or price of investments or which secures an abnormal or artificial price; placing orders which are fictitious a sophisticated investor certified as experienced or deceptive; disseminating information giving in relation to the investment or fund which the misleading impressions and engaging in conduct broker/dealer is promoting . which a regular user of the market would view as There are also limited exemptions for overseas distorting the market . communicators and exemptions for generic The Code of Market Conduct within the FCA promotions . The latter exemption covers all types Handbook provides guidance on how the of activity, but only exempts promotions which do definitions of market abuse should be applied and not name any particular product or provider . provides certain safe harbours . Some exemptions require prominent disclosures to The Market Abuse Directive (MAD) imposes be included within the financial promotion before obligations on listed companies to control access to the exemption may be used . inside information on a need to know basis and to INSIDER DEALING AND MARKET maintain lists of persons within their organisations ABUSE who have access to inside information . Criminal The EU Market Abuse Regulation (MAR), together with a criminal sanctions Directive (CSMAD)4 will Insider dealing is a criminal offence under replace MAD from July 2016 . MAR will extend the section 52 of the Criminal Justice Act 1993 . The scope of the existing EU market abuse regime to maximum sentence on conviction is seven new products and trading venues, reinforce the years’ imprisonment . investigative and sanctioning powers of regulators, Market manipulation is a criminal offence under and introduce a new expanded definition of section 89-90 of the Financial Services Act 2012 . It inside information . covers the deliberate or reckless making of Authorised firms must report suspicious statements or forecasts which are false, misleading transactions, which may amount to market abuse, or deceptive; the dishonest concealment of to the FCA . material facts; and any conduct creating a false or misleading impression of the market in relevant Change of control of businesses investments . Section 91 of the Financial Services authorised under FSMA Act 2012 also creates the offence of market manipulation in relation to the setting See Chapter 7 above . of benchmarks .

4 The UK has opted out of CSMAD as it already has a criminal regime for insider dealing which goes beyond that proposed in CSMAD. HERBERT SMITH FREEHILLS Raising finance 43

9. Raising finance

The focus of this section is on debt raised) is very dependent on market conditions – see below . finance provided to companies incorporated in England and Wales . TYPES OF LOAN FACILITY The two key types of loan facility used by corporate LOAN FACILITIES borrowers are the term loan and the revolving credit A loan facility can provide a corporate borrower with facility . There are many other variances and some financing which is both reliable and tailored to the key ones are discussed in more detail below . particular purpose of the loan . For example, a company looking to ease its cash flow could obtain Although the emphasis in this section is on the an overdraft facility which would provide it with borrower, the key terms of the loan agreement (for instant access to variable sums of money, whilst a example the representations, warranties, covenants company aiming to fund a specific investment could and events of default) often apply also to all or some enter into a term loan (the loan of a lump sum for a of the other companies in the borrower’s group . specific period of time) – see below . TERM LOANS DEBT CAPITAL MARKETS INSTRUMENTS A term loan provides a corporate borrower with a specified sum of capital over a specified period This form of financing involves a company (the known as the term . The term of a loan for general issuer) issuing debt securities to investors in return corporate purposes is not normally more than for the loan of capital to the company . These debt five years . securities usually provide that the issuer will repay the capital on a specified date (known as the Term loans are usually committed facilities, which maturity date) and that interest will be paid on the means that the loan agreement contains an capital until that date . Debt securities can be sold by obligation by the lender to advance monies to the the original investor and the issuer will then pay borrower at the borrower’s request (provided that interest (and eventually repay the capital) to the the borrower has satisfied certain pre-agreed current owner of the debt security . conditions known as conditions precedent) .

A company may wish to issue debt securities to raise Under a standard term loan facility, there will be a capital rather than enter into a loan facility . There are short period at the beginning of the term during which a number of reasons for this, including for example, a the borrower can draw a lump sum up to a specified company may have access to a larger number and maximum amount . Alternatively, a term loan can greater range of lenders (ie, investors) by issuing allow drawings to be made in a series of advances such instruments, the cost of the capital may be less when the borrower needs the finance, which means expensive (because of the liquidity of the markets), that it borrows according to its specific requirements . the size and maturity of the debt can be more varied (because the market is more extensive and investors The loan agreement will either require repayment of can invest in small participations) and generally the the loan by instalments at specified intervals or in terms of a debt security will be less onerous and one sum at the end of the term . restrictive than those of a typical commercial loan facility . Of course, however, the ability to raise capital The borrower will be required to pay interest on the by this method (and the terms on which it can be loan – see below . 44 Raising finance HERBERT SMITH FREEHILLS

Raising finance

REVOLVING CREDIT FACILITIES THE LOAN AGREEMENT Under a revolving credit facility, the borrower is still Representations and warranties provided with a capital sum which is made available Put simply, representations and warranties are over a specified period . However, the main difference statements of fact made by the borrower in the loan between a term loan and a revolving credit facility is agreement . They are a means of ensuring full that under the latter the borrower can draw down disclosure to the lender of all relevant facts . The and repay advances of the available capital other main reasons for including these statements in throughout the life of the loan . Each advance is the loan agreement are to provide a drawstop (the usually borrowed for a short period of one, three or loan agreement provides that money can only be six months, at the end of which it is repayable . But if drawn by the borrower if the representations are the borrower is not in default, an advance can be true) and a specific contractual remedy in the event immediately re-drawn (a “rollover”) . A commitment of their breach (the lenders may demand repayment fee will be payable in respect of the revolving credit of the loan) . facility, which is usually a percentage of the undrawn facility from time to time . Representations may relate to legal or commercial matters . An example of a legal representation is that BILATERAL AND SYNDICATED FACILITIES the borrower has the capacity to enter into a loan agreement and to perform its obligations . An Bilateral facilities – these facilities involve just two example of a commercial representation is that the parties, the borrower and the lender . They are used borrower is not in default under any other finance for smaller loans and overdraft facilities . agreements (cross default) . Syndicated facilities – for larger loans (for example, an acquisition funding), the finance is usually The lender will require some of the representations provided by a group of banks or other finance and warranties to be repeated throughout the term providers known as a syndicate . The syndicate of the facility . If the relevant repeated representation members will all be party to common is untrue at the time of its repetition, this may trigger documentation but they may contribute different an event of default – see below . loan amounts and will only be liable for their own COVENANTS (INCLUDING FINANCIAL obligations . One bank takes the role of agent and is COVENANTS) responsible for co-ordinating the syndicate members and acting as the liaison between them Covenants are undertakings given by the borrower to and the borrower . the lender in the loan agreement . Their purpose is to give the lender some control over the borrower, its SECURED AND UNSECURED FACILITIES assets and activities, by either requiring positive action by the borrower or by prohibiting the borrower Lenders will normally take security over the assets of from doing something . Breach of a covenant will the borrower in order to increase the likelihood of trigger an event of default . recovering the amounts they have lent if the borrower defaults . This is particularly important if the borrower Examples of non-financial covenants include becomes insolvent, as the security will give the lenders information covenants (eg, to provide regular priority over other creditors of the borrower, allowing financial information), positive covenants (eg, to them to maximise their recoveries . obtain and maintain insurance) and negative HERBERT SMITH FREEHILLS Raising finance 45

covenants (eg, a covenant which imposes cover the bank’s regulatory capital requirements in restrictions on disposals) . respect of money which it is committed to lend but which has not yet been drawn) . Financial covenants are financial targets which the Agent’s fees – payable to the bank which takes on borrower undertakes to meet . Their purpose is to the role of agent . protect the lender’s capital and interest and to impose financial discipline on the borrower . Cancellation fees – payable in the event that the loan facility (or part of it) is never used (eg, in The scope of the covenants will depend on the type acquisition financing, where a company’s bid for a of borrower and its business, the purpose of the loan target fails) . and the level of risk . SECURITY EVENTS OF DEFAULT Some common forms of English law security are: Events of default are circumstances which entitle the Fixed charge – A fixed charge gives the lender lender to terminate the loan early, cancel any rights over the charged assets which prohibit the commitment and demand repayment of all borrower from disposing of them without outstanding principal and interest . This process is permission and allow the lender recourse to the known as acceleration of the loan . assets should the borrower default under the loan . On a default, the lender may sell the asset or Common events of default include late payment, appoint a receiver to organise the sale . breach of a covenant and insolvency events . Floating charge – Floating charges are used to take INTEREST security over a group of assets which may fluctuate The interest on commercial loans payable by the from time to time . A key difference between a fixed borrower is usually at a floating, not fixed, rate . A and a floating charge is that a floating charge floating rate of interest is normally the sum of the allows the borrower to deal with the charged interbank funding rate (for example, in the London assets in the ordinary course of business . However, market this is known as the London Interbank Offered on the occurrence of specified events, the floating Rate (LIBOR)), the lender’s margin or profit and (in charge will effectively become a fixed charge – it some cases) mandatory costs, which reflect the costs crystallises . Upon crystallisation the borrower is of complying with certain regulatory charges . then unable to dispose of the assets subject to the charge unless it obtains the lender’s prior consent . FEES Mortgage – A mortgage transfers ownership of an The nature of the loan facility will determine the type asset to the lender . The lender has a right to sell the of fees and market conditions which will impact on asset on default and an obligation to re-transfer the level of fees payable by the borrower . Common title on repayment of the debt . examples include: Assignment – Assignment is the transfer of rights Front end fees – payable in respect of the initial but not obligations . An assignment will transfer to work involved in putting the loan together . the lender all the borrower’s rights under the relevant agreement . A provision for reassignment Commitment fees – payable in respect of the on satisfaction of the debt will always be included undrawn uncancelled commitments (this is to in assignments by way of security . Assets which 46 Raising finance HERBERT SMITH FREEHILLS

Raising finance

are usually secured by assignment are the is no longer prohibited from providing direct or borrower’s rights against third parties (choses in indirect financial assistance in connection with the action) eg, debts and rights under contracts . acquisition of its shares or shares in its holding company . Note, however, that the prohibition GUARANTEES remains for public companies under the Companies A guarantee is an undertaking by one party (the Act (sections 677 to 683) . Financial assistance guarantor) to answer for the obligations of another issues will therefore arise if the transaction involves a party, normally upon default by that other party . public company, even if the company giving the Guarantees are often given by the borrower’s parent financial assistance is a private company . company or by another company in the same group . The guarantor may also be required to give security The definition of financial assistance specifically over its own assets to support its potential liability includes financial assistance given by way of under the guarantee . guarantee, security or indemnity . OTHER ENTITIES SEEKING FINANCE Certain tax consequences may flow (for example, under the UK transfer pricing rules) from the Companies are not the only entities which could be payment of (or failure to pay) or the receipt of a seeking financing . Other types of borrower include guarantee fee between connected companies . Very governments, local authorities, partnerships and broadly, the transfer pricing rules apply where one sole traders . company directly or indirectly participates in the management, control or capital of the other and the DEBT CAPITAL MARKETS rules broadly require the parties to price (for tax INSTRUMENTS – FURTHER DETAIL purposes) transactions on the basis that they were Raising capital through debt capital markets unconnected parties . instruments is generally effected by the borrower (called the issuer) issuing a debt security generally Care should also be taken when a guarantor assumes known as a bond or note . The terms bond and note the rights and liabilities of a borrower under a loan in are now often used interchangeably as there is no circumstances where the loan is subject to the terms difference in form or content between the two, of a treaty agreement (or the loan operates under a although historically they did refer to different types treaty passport) with HMRC . Where such an of debt securities depending on the maturity of the agreement or passport applies (and assuming there security or the type of interest which the is UK source interest), the borrower may withhold a security carried . lower rate of UK tax on payments of interest to the lender or may be able to pay those amounts gross . If A bond is a certificate of debt under which the issuer the guarantor is in a different jurisdiction to the promises to pay the principal amount borrowed to borrower, the applicable rates of interest withholding the lender (referred to as the bondholder) on the may change and may therefore require a new treaty maturity date of the bond . There are no specific rules agreement with HMRC . More information on relating to the maturity of a bond . withholding tax obligations can be found below . The main characteristics of a bond are: FINANCIAL ASSISTANCE it is a debt obligation, typically in bearer form, in As mentioned in Chapter 4 above, a private company HERBERT SMITH FREEHILLS Raising finance 47

the form of a transferable instrument; Zero coupon bonds – Zero coupon bonds do not pay any interest, however they are issued at a discount, it is sold by way of marketing to a large number of ie, the amount which the investor pays for a zero investors through a syndicate of financial coupon bond on issue is less than its face value organisations, or it is sold to a small group of on redemption . specifically targeted investors; it is a marketable instrument (ie, typically it has an Equity linked bonds – These bonds are linked to the established secondary market); equity (eg, the share capital of the issuer) and provide an investor with the opportunity to obtain it may be listed on a recognised stock exchange; some form of equity interest in the issuer or it will generally be unsecured; another company .

it may be rated by a credit rating agency to THE FORM OF A BOND enhance marketability; and Bonds can be issued in one of two forms: bearer it will bear interest or be issued at a or registered . discounted price . Bearer bonds – Bearer bonds are negotiable TYPES OF BOND ISSUE instruments whose title passes by delivery of debt Depending on various factors including the type of securities . This means that passing the bond to transaction, prevailing market conditions and the another person transfers ownership; the bond itself credit rating of the issuer, a wide range of different is proof of ownership . types of bonds can be issued . The simplest include: Registered bonds – Unlike bearer bonds, registered Fixed rate bonds – A fixed rate bond has a rate of bonds are not negotiable instruments and title interest which is fixed at the time of issue and will passes by registration of the bondholder’s name in a not change during the life of the bond . The interest register . Registered bonds will be used where there is usually payable annually (or semi-annually in the are US bondholders because of US tax concerns . case of some emerging markets issuers) in arrear . Both bearer and registered bonds will generally be Floating rate bonds – Floating rate bonds (referred held and traded through clearing systems in the form to as notes) pay interest which fluctuates in of global notes or certificates (as opposed to accordance with a variable benchmark rate plus definitive or individual certificates) . The clearing a margin . systems provide safe custody for, collect payments on and facilitate the transfer of, securities . The Variable rate bonds – Variable rate bonds have a principal clearing systems for bonds are Euroclear rate of interest which varies throughout their term, and Clearstream in Europe . although unlike floating rate notes, the rate does not vary freely in accordance with an In order for bonds to be recognised as eligible underlying benchmark . Eurosystem collateral, global bearer bonds are required to be in the form of New Global Notes (or NGNs) and registered bonds held through the New Safekeeping Structure (or NSS) . 48 Raising finance HERBERT SMITH FREEHILLS

Raising finance

KEY REGULATORY ISSUES regard, there are a number of different tax rules that need to be considered . Broadly, a borrower may be At the outset, an issuer must ensure that it can able to claim a deduction for interest payments, actually issue bonds . It must check that there are no discounts and related borrowing costs (under the legal barriers in its jurisdiction and in its loan relationship rules) on an accruals basis subject constitutional documents that would prevent it from to certain exceptions . issuing bonds and will need to appoint lawyers in its jurisdiction to assist with this . Relief for interest may, however, be denied (in whole or part) where: In addition, the EEA prescribes regulations which restrict the offering of bonds to the public . It is there is a tax avoidance motive; unlawful for securities to be offered to the public in where the interest can be re-characterised as the UK unless an approved prospectus has been a distribution; made available to the public before the securities are so offered . There are certain exemptions to this where the transfer pricing rules apply; or requirement such as offers made to institutional where the so called debt cap rules apply . investors . In the UK, supervision of compliance with this regime is handled by the FCA . In addition the UK has a General Anti-Abuse Rule (GAAR), briefly described in the tax section in There are also US restrictions on issues of securities Chapter 13 below, which may impact on structures which need to be considered even for companies with used to raise finance . no connection with the US . Typically a bond is issued as a Reg, S bond which cannot be sold into the US or to WITHHOLDING TAX OBLIGATIONS US beneficial owners or a Rule 144A bond which can only be sold in the US to US qualified institutional The UK also imposes withholding tax on some buyers . Bonds are often issued with a stock exchange payments of UK source interest . Whether interest is listing to enhance their marketability and take UK source will depend on a number of factors advantage of the quoted Eurobond exemption which including (but not limited to), the situs of borrower, allows an issuer in the UK not to deduct tax on interest the location of any security for the loan (eg, whether at source . In order to gain a listing, a prospectus is there is any UK land) and the jurisdiction or required, the approval of which is required from the governing law for the loan documents . relevant listing authority (in the UK, the UK Listing Authority operated by the FCA) . Interest can be paid gross between associated resident companies of EU Member States but certain KEY TAX ISSUES RELEVANT TO conditions must be satisfied . For other overseas RAISING FINANCE lenders, the rate of withholding tax depends on A number of UK tax issues will arise in the context of whether there is a double tax treaty in place . The raising finance and specific (and early) advice should maximum rate is 20% . be sought . Clearance from HMRC and other tax authorities may DEDUCTIONS FOR THE INTEREST need to be obtained before interest can be paid gross EXPENSE or at the reduced rate (under the terms of a treaty) . Although clearance may sometimes be obtained in Perhaps the key issue for the borrower is the advance (for example under HMRC’s double tax deductibility of the interest expense and in this HERBERT SMITH FREEHILLS Raising finance 49

treaty passport scheme or its syndicated loan For UK FFIs, compliance with the FATCA legislation is scheme) in other circumstances a double tax relief regulated by an intergovernmental agreement claim can only be submitted once the loan between the US and the UK . This enables UK FFIs to agreement has been entered into . This can take time comply with FATCA without breaching data (and may require (lengthy) correspondence with the protection laws and reduces some of the tax authorities of the counterparty jurisdictions and administrative burden . The requisite information can local lawyers’ advice) which needs to be built into be passed by the UK FFI to HMRC and HMRC will any transaction timeframe . then forward it on to the US tax authorities .

PROPOSED FINANCIAL FATCA is likely to be particularly relevant to finance TRANSACTIONS TAX (FTT) transactions and investors may well need to certify Speculation is on-going regarding the possible that they have no US account holders (if an FFI) or introduction of a FTT (which, although originally are in fact FATCA compliant . Similarly, parties may proposed to be Europe-wide, is now restricted to seek FATCA indemnities in finance documents . 11 Member States) . The UK remains strongly opposed to its introduction and has gone as far as US advice may be needed to fully assess the impact taking legal action to challenge it . Even amongst of FATCA and this may have a bearing on Member States who wish to introduce FTT, there is transaction timescales . still significant disagreement as to the scope and operation of the tax, which will not come into force IRS CIRCULAR 230 DISCLOSURE until 2015 at the earliest . If introduced in Member This document is not intended to be fully States outside the UK, it may still impact on UK-led comprehensive, nor to provide US tax advice . financing transactions . Notwithstanding this, to ensure compliance with requirements imposed by the Internal Revenue FOREIGN ACCOUNT TAX COMPLIANCE Service (IRS), we inform you that any US tax ACT (FATCA) information contained in this communication The FATCA legislation is a complex piece of US (including any attachments) is not intended or anti-avoidance tax law that has extra territorial written to be used, and cannot be used, for the impact and its impact may need to be considered purpose of: (i) avoiding tax-related penalties under even in respect of transactions that do not appear to the Internal Revenue Code; or (ii) promoting, have any US connection . What follows is a very brief marketing or recommending to another party any overview only of the FATCA rules . transaction or matter addressed herein Recipients of this document should seek advice based on their In essence, the FATCA legislation requires certain particular circumstances from an independent, foreign financial institutions (FFIs – widely defined) appropriately qualified, tax advisor . and non-financial foreign entities (NFFEs – also widely defined) to effectively agree to provide certain information on US persons that have accounts in the FFI, or own a substantial part of the NFFE, to the US tax authorities or face a 30% withholding on payments received that are considered to be US source (which include US source dividends, interest, rents and gross proceeds from sale) . 50 Competition law HERBERT SMITH FREEHILLS

10. Competition law

The key competition rules are set The restrictions on competition can arise from a horizontal agreement (an agreement between out in the UK Competition Act 1998 parties at the same level in the supply or distribution (Competition Act), the Enterprise chain) or from a vertical agreement (an agreement Act 2002 and the Treaty on the between parties at different levels in the supply or distribution chain) . Typical horizontal restrictions are Functioning of the European Union price-fixing, customer or market sharing, fixing (TFEU) . The anti-trust provisions of production quotas or joint selling or purchasing arrangements . Typical vertical restrictions are the Competition Act mirror those of exclusive supply and purchase obligations, the TFEU, and will apply unless non-compete clauses, export bans and resale price there is an effect on trade between maintenance . Horizontal restrictions are generally regarded as more serious breaches of competition EU Member States, in which case law because they involve co-ordination between the provisions of the TFEU will competitors and are more likely to have a significant adverse impact on competition, but vertical be relevant . restrictions can also breach the prohibition on ANTI-COMPETITIVE AGREEMENTS AND anti-competitive agreements . PRACTICES If an agreement is caught under Article 101(1) or the Article 101(1) TFEU and the Chapter I prohibition in Chapter I prohibition, the prohibition may nevertheless the Competition Act prohibit agreements between be inapplicable if it can be shown that the agreement undertakings which may affect trade between EU contributes to improving the production or distribution Member States (or trade within the UK) and have as of goods or to promoting technical and economic their object or effect the prevention, restriction or progress, while allowing consumers a fair share of the distortion of competition . The term agreement is benefit . The exemption will only be available if any widely defined and will include informal, oral, ad hoc restrictions on competition are essential to achieve arrangements, gentleman’s agreements, simple these objectives and as long as they do not allow understandings and concerted practices which fall competition to be substantially eliminated . It is up to short of formal written agreements . The provisions companies and their legal advisers to make the set out a non-exhaustive list of examples of assessment as to whether or not an agreement anti-competitive agreements: benefits from this exemption . fixing purchase or selling prices or other trading conditions; The EU Commission has the power to adopt Regulations, known as block exemptions, which limiting or controlling production, markets, disapply Article 101(1) from certain categories of technical development or investment; agreement (there is a parallel exemption from the sharing markets or sources of supply; and Chapter I prohibition for such agreements under the Competition Act) . applying dissimilar conditions to equivalent transactions with other parties, thereby placing If an agreement meets the conditions set out in the them at a competitive disadvantage . relevant block exemption, it is automatically exempt from Article 101(1)/Chapter I prohibition . The main HERBERT SMITH FREEHILLS Competition law 51

block exemption Regulations available are those ABUSE OF DOMINANCE dealing with vertical agreements, technology Article 102 TFEU and the Chapter II prohibition of the transfer agreements, specialisation agreements and Competition Act prohibit abuse by dominant research & development agreements . companies of their dominant position . There is nothing THE UK CARTEL OFFENCE wrong with being dominant in itself, but companies which are deemed to be dominant are subject to Under Section 188 of the Enterprise Act 2002 an greater regulation than their smaller rivals . Generally individual is guilty of an offence if s/he agrees with speaking, as a rule of thumb, a company may be one or more persons to make or implement or cause regarded as dominant if it commands a market share to be made or implemented, arrangements whereby of 40% within a properly defined relevant product at least two undertakings will engage in one or more market . The provisions set out a non-exhaustive list of prohibited cartel activity . The prohibited activities are conduct that may constitute an abuse: direct or indirect price-fixing, limitation of production or supply, sharing customers or markets and Pricing abuses . Unfair pricing practices include: bid-rigging . Individuals found guilty of the offence are excessively high pricing; liable to a maximum imprisonment term of five years and/or an unlimited fine . Under Section 188A a predatory pricing (designed to eliminate person does not commit the cartel offence if either: competitors); customers are given “relevant information” before discriminatory pricing (charging different prices entering into the arrangement; or to similarly placed customers); and the person requesting the bid is given “relevant unfair fidelity or loyalty rebates or similar pricing information”’ before the bid is made; or schemes . before the arrangements are implemented, Refusal to supply . It has been held on a number of “relevant information” is published in any of the occasions to be an abuse for a company in a London Gazette, the Edinburgh Gazette or the dominant position to refuse to supply products or Belfast Gazette . services, or to refuse access to resources which it controls, unless there was an objective justification Relevant information is defined in Section 188A(2) for doing so . as: the names of the undertakings to which the Tying and bundling . This occurs where a supplier arrangements relate, a description of the nature of agrees to supply particular products or services the arrangements and the products or services to only if the purchaser agrees to buy other unrelated which they relate . products or services from the supplier .

In addition, it will be a defence for an individual who ENFORCEMENT AND FINES is charged with the cartel offence to show either that Competition rules in the UK will be enforced by the they did not intend to conceal the arrangements from CMA unless the EU Commission decides it should customers or from the Competition and Markets take on the case because there is a wider EU interest Authority (CMA), or that before making the involved . Both the EU Commission and the CMA agreement they took reasonable steps to obtain legal have wide powers of investigation . They can request advice (Section 188B) . companies to supply them with information and they 52 Competition law HERBERT SMITH FREEHILLS

Competition law

can enter a company’s premises to inspect and take copies of its business records, in whatever form they are maintained (so called dawn raid powers) .

An agreement or practice that is prohibited under the competition rules is void (so that it cannot be enforced by the company) and the parties to it may be subject to heavy fines . Fines of up to 10% of worldwide group turnover for the previous financial year can be imposed . Third parties who have suffered a loss as a result of an infringement can bring private actions for damages .

Under the UK cartel offence, individuals engaged in the unlawful action may be liable to criminal prosecution . This could result in the payment of an unlimited fine and/or prison sentences of up to five years .

A UK court can also make a competition disqualification order against a company director, if the company of which that person is a director has committed a breach of competition law and the court considers that person’s conduct as a director makes him or her unfit to be involved in the management of a company . The maximum period for which a director can be disqualified is 15 years .

Where competition law infringements have been committed, early detection is key in mitigating potential adverse consequences . Both the EU Commission and the CMA operate so-called leniency programs, designed to provide full or partial immunity from fines to those companies that voluntarily come forward with details of infringements and actively co-operate with any subsequent investigation . Full immunity is generally available only to the first company to come forward with evidence of an infringement . HERBERT SMITH FREEHILLS Merger control 53

11. Merger control

Depending on the size of the lasting basis all of the functions of an autonomous economic entity) . transaction, the applicable merger control rules will be either the EU or EU dimension the UK merger control rules . In There are two alternative tests to establish whether a addition, and depending on the concentration has an EU dimension . The second test was introduced in order to catch transactions which markets in which the parties to the are of less value but would otherwise require multiple transaction are active on and the national filings . turnover of the parties, other The first test international merger control regimes Under this test a concentration will have an EU may be relevant and will need to be dimension if it satisfies two conditions: considered . the combined worldwide turnover of all the undertakings concerned is more than €5,000 million; The EU Merger Control Regulation (EUMR) has and created a one stop shop regime under which a the EU-wide turnover of each of at least two of the transaction is, within the EU, either subject to the undertakings concerned is more than €250 million . EUMR or to national merger controls, but not both . There are a few exceptions to this rule which are However, any concentration where each of the aimed at ensuring that the best placed authority will undertakings concerned achieves more than deal with each transaction . two-thirds of its EU-wide turnover in one and the same Member State does not have an EU dimension . EU MERGER CONTROL In such case the Member State concerned, rather Form of the transaction – concentration than the Commission will have jurisdiction . The EUMR applies to concentrations which have an The second test EU dimension . A concentration is defined as a merger of two or more previously independent If the concentration does not have an EU dimension undertakings, or the acquisition of direct or indirect under the first test, it will still fall within the scope of control of the whole or parts of another undertaking . the EUMR if: The trigger for jurisdiction is a change of control . the combined aggregate world-wide turnover of Control for these purposes is defined as the ability to all the undertakings concerned is more than exercise decisive influence over an undertaking on €2,500 million; the basis of rights, contracts or other means and is most commonly obtained through the acquisition of in each of at least three Member States, the a direct or indirect shareholding in the target . combined aggregate turnover of all the Concentrations can include mergers, take-overs undertakings concerned is more than €100 million; (hostile or agreed), rescues, exchanges of substantial in each of at least three Member States included for minority shareholdings, acquisitions of part of a the purpose of the above requirement, the aggregate business, contractual links which convert a minority turnover of each of at least two of the undertakings shareholding into a controlling stake and full-function concerned is more than €25 million; and joint ventures (joint ventures which perform on a 54 Merger control HERBERT SMITH FREEHILLS

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the aggregate EU-wide turnover of at least two of the doubts about a concentration, it allows the undertakings concerned is more than €100 million . transaction to proceed on the basis of a reasoned decision which explains why the concentration is As under the first test, if each of the undertakings compatible with the EU market . concerned achieves more than two-thirds of its aggregate EU-wide turnover in one and the same If the Commission has serious doubts which cannot Member State, that Member State rather than the be dispelled, it will produce a reasoned decision Commission will have jurisdiction over expressing those doubts and notifying the parties the concentration . that a second stage (Phase II) investigation is being opened . The Commission has 90 working days EUMR notification (extendable by 15 days if undertakings are offered by Concentrations with an EU dimension must be notified the parties and by a further 20 days at the request of to the Commission prior to their implementation the parties) to complete its investigation . At the end (closing the transaction) and following the conclusion of Phase II, the Commission can approve the merger of the relevant agreements, the announcement of a (with or without undertakings) or prohibit it . public bid, or the acquisition of a controlling interest . UK MERGER CONTROL Early notification is possible in cases where the parties can demonstrate a good faith intention to conclude an The UK merger control regime is set out in Part 3 of agreement, for example upon the execution of a the Enterprise Act 2002 . The regime consists of a non-binding letter of intent . two-stage process . At Phase 1, the Competition and Markets Authority (CMA) considers whether the The completion of the concentration with an EU transaction raises prima facie competition concerns . dimension is automatically suspended until it has Phase 2 consists of a longer and more detailed been cleared by the Commission . The Commission investigation of potentially problematic may exceptionally grant a derogation from this transactions . At the end of Phase 2, the CMA can suspension period, taking into account factors such either clear the transaction, with or without as the effects of the suspension on one or more of remedies, or prohibit the transaction . the undertakings concerned and the threat to competition posed by the concentration . Failure to Jurisdictional thresholds notify, or the implementation of a transaction prior The CMA has jurisdiction over “relevant merger to clearance, can give rise to substantial fines for situations” which do not fall within the jurisdiction of the parties of up to 10% of the aggregate turnover the EU Merger Regulation . A transaction will give rise of the undertakings concerned . Failure to suspend to a relevant merger situation where: the agreements giving effect to the concentration pending clearance also causes them to two or more enterprises cease to be distinct; and be unenforceable . either the value of the turnover in the UK of the enterprise being taken over exceeds £70 million The Commission’s review procedure (the turnover test); or The Commission has 25 working days from receipt as a result of the transaction the merged entity will of notification to conclude its first stage (Phase I) supply or purchase 25% or more of goods or investigation, extended to 35 working days if services of a particular description in the UK (the undertakings are offered or if a referral request is share of supply test) . made . If the Commission does not have serious HERBERT SMITH FREEHILLS Merger control 55

Notification Phase 2 . Informal Advice is only available for good faith confidential transactions and where the CMA’s There is no obligation to notify mergers in the UK, duty to refer is a genuine issue . although in practice a large number of transactions are notified in the interest of legal certainty . When Substantive assessment deciding whether or not to notify, parties should know that the CMA may become aware of the The Enterprise Act imposes a duty on the CMA to merger, either because of third party complaints, or refer completed and anticipated mergers for an as a result of its own market intelligence function, in-depth Phase 2 investigation if it believes that it is and decide to launch an own-initiative investigation . or may be the case that a relevant merger situation The CMA may ultimately require the parties to undo has been or will be created and the creation of that a completed transaction following an adverse situation has resulted, or may be expected to result, finding . At the start of an investigation the CMA will in a substantial lessening of competition (SLC) in the also normally impose an interim order on completed UK . The test for reference will be met if the CMA has mergers, in order to prevent or unwind pre-emptive a reasonable belief, objectively justified by relevant action (action which might prejudice the outcome of facts, that there is a realistic prospect that the the reference and/or impede the CMA taking merger will lessen competition substantially . appropriate remedies) . An interim order will remain in force until the merger is cleared or remedial action Where the test for a Phase 2 reference is met, the is taken . For anticipated mergers it will do so in CMA may accept undertakings in lieu of a reference exceptional cases, where pre-emptive action is (UILs) from the parties as an alternative to making a difficult or costly to reverse . Phase 2 reference .

Notification to the CMA is made by completing the Following a reference for a Phase 2 investigation, the Merger Notice . The CMA strongly advises notifying CMA conducts a more detailed analysis to determine parties to engage in early pre-notification discussions, whether there is a relevant merger situation, whether in particular for cases where competition concerns that situation has resulted or may be expected to cannot be ruled out . The Merger Notice requests large result in a SLC, and whether it should take action to amounts of information and pre-notification remedy any SLC identified . At Phase 2, these decisions discussions will assist the parties to determine are taken by an Inquiry Group, selected from the precisely what information will be required for a independent experts on the CMA’s panel . “satisfactory notification” . Remedies Fees are charged on a sliding scale, between £40,000 If, following a Phase 2 reference, the CMA concludes and £160,000 depending on the size of the that a merger has resulted or may be expected to transaction and become payable on the publication by result in an SLC, the CMA is required to decide the CMA of either a reference decision or any decision whether action should be taken to remedy, mitigate not to make a reference (except where the case is or prevent the SLC or any adverse effect resulting found not to qualify as a relevant merger situation) . from the SLC . Remedies may include prohibition of the transaction, divestiture of part of the acquired Informal Advice business (or, in the case of a completed merger, It is possible to apply to the CMA for Informal potentially divestiture of the whole of the acquired Advice, under which the CMA will give its view on business by the purchaser), intellectual property whether it would be likely to refer a transaction to remedies or behavioural remedies . 56 Merger control HERBERT SMITH FREEHILLS

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Timetable question . Public interest considerations currently listed are: (i) national security (including public The CMA has a statutory time period of 40 working security); (ii) media plurality and quality; and (iii) days (which will be subject to “stop the clock” the stability of the financial system . provisions if responses to statutory information requests are outstanding) for the Phase 1 Specialist merger control regimes are retained for investigation . The time limit starts to run on the first transactions in the water and newspaper industries . working day after a satisfactory notification has been received for mergers notified by way of a Merger Notice, or otherwise where the CMA notifies the relevant persons that it has sufficient information to investigate .

The statutory time period for UILs requires the parties to offer UILs within five working days from announcement of the Phase 1 decision . The CMA will have up to the 10th working day after the date of the Phase 1 decision to consider the UILs proposed by the parties and decide whether to pursue UILs and suspend the duty to refer . If the CMA issues a notice suspending its duty to refer, it will have 50 working days from the decision in order to decide whether or not to accept the UILs . This period can be extended once by up to 40 working days if there are special circumstances (eg, where an upfront buyer is required) .

The CMA has a statutory time period of 24 weeks to complete its Phase 2 investigation, which may be extended by a maximum of eight weeks in special circumstances . Following publication of the final report, there is a 12 week statutory time period for adopting final remedies . This will be subject to a stop the clock provision where the CMA is waiting for further information, and can be extended by six weeks for special reasons .

Special regimes Public interest mergers: the Secretary of State can intervene in a merger situation under consideration on public interest grounds, by means of giving an intervention notice to the CMA if s/he believes that it is or may be the case that public interest considerations are relevant to the merger in HERBERT SMITH FREEHILLS Employees 57

12. Employees

On acquiring or setting up a business leading to a significant reduction in claims . A further change is that claims issued from 6 May 2014 will or company in the UK, there will only be accepted by the Tribunal if the claimant has inevitably be employees and it is first contacted Acas, which will then offer the parties important to understand some of the free early conciliation . From April 2014 Tribunals will have the power to order an employer who has lost at key UK employment law issues that Tribunal to pay a financial penalty of up to £5,000 to apply in England and Wales . the Secretary of State, where the case has (Although most statutory and “aggravating features” . contractual employment rights in THE CONTRACT OF EMPLOYMENT Scotland and Northern Ireland are Where are the terms found? the same as in England and Wales, Employers must give employees a written there are occasional differences statement of the main terms of their employment within two months of the job starting . If they fail to which are not covered in this guide ). do so, the employee may apply to an Employment Tribunal for a declaration of terms (or, if they have SOURCES OF EMPLOYMENT LAW an additional claim, for compensation of up to a Much UK employment law comes from EU maximum of £1,856 (as of 6 April 2014) . In legislation, so one might expect the position to be practice most employees will be given a fuller similar throughout Europe . However, there are employment contract, setting out a whole range of significant differences: UK law emphasises the terms covering remuneration, duties, termination individual agreement between employer and provisions and so on . employee with an overlay of statutory rights, The courts will also imply certain terms into an whereas in many EU countries employment is employment contract, such as the requirement to regulated by industry sector collective agreements . give reasonable notice of termination (if there is no express term), the employee’s duty of One key point to note is that UK statutory confidentiality, fidelity and good faith, and the duty employment rights will continue to apply even if the on both employer and employee not to conduct employment contract is expressed to be governed by themselves in a manner calculated and likely to a foreign law . Likewise, clauses requiring employees destroy the relationship of trust and confidence to refer disputes to arbitration will not be effective to between them . A term can also be implied if it is a prevent them bringing claims for breach of custom or practice . statutory rights . Employment terms may also derive from collective Statutory claims must be brought in the Employment bargaining with a recognised trade union . Tribunal; contractual claims can be brought in the Recognition of unions can be voluntary or Employment Tribunal (subject to certain limits) or in compulsory (if the majority of employees support the civil courts . Tortious claims (eg, for negligence) it); the latter entitles the union to bargaining rights must be brought in the civil courts . in relation to pay, hours and holidays .

Fees to issue and hear Employment Tribunal claims were introduced for the first time in July 2013, 58 Employees HERBERT SMITH FREEHILLS

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Terms applying post-termination Failure to give notice (or exercise a contractual payment in lieu provision) entitles employees to Contracts will often contain express prohibitions claim damages for wrongful dismissal representing on what an employee can do after leaving the lost salary and benefits during what would have been employment . Without such provisions, employees the notice period, subject to the employee’s duty to are not prevented from competing or poaching mitigate his loss by seeking new employment . customers or employees, only from using or disclosing trade secrets . UK courts will only Directors/financial services enforce express restrictive covenants (even if governed by a foreign law) if they are reasonable There are additional requirements in relation to the and no wider than is necessary to protect a terms of directors’ service contracts and executive legitimate business interest (eg, confidential pay, which are not covered by this briefing . There are information or customer connections), provided also specific rules governing particular sectors, for the employer has not itself fundamentally example, the EU-derived bankers’ bonus cap breached the contract . introduced in January 2014 and currently subject to legal challenge by the UK Government . An alternative means of keeping departing employees out of the marketplace is the use of an STATUTORY RIGHTS express garden leave clause, enabling the Unfair dismissal employer to make an employee stay at home during their (paid) notice period . After two years of service (or one year for those who started employment before 6 April 2012) an Termination employee has the statutory right not to be unfairly UK employees have both statutory and contractual dismissed . A failure to renew a fixed-term contract is rights on termination . treated as a dismissal . An employee can also resign and claim that he has been constructively dismissed Notice rights where the employer has fundamentally breached the contract (eg, a breach of the implied duty of trust and Under statute, employees are entitled to a minimum confidence) . Employees working outside the UK may period of notice prior to dismissal once they have in some circumstances be able to claim unfair worked for at least a month, unless dismissed for dismissal in the UK if they have a sufficiently strong gross misconduct . Minimum notice by the employer connection with the UK . is one week (where the employee has worked less than two years), then one week per year of service up A dismissal will be fair if the principal reason for the to a maximum of 12 weeks; notice by the employee is dismissal and the procedure adopted in dismissing one week (once the employee has worked for one are both fair . There are five potentially fair reasons: month) . However, employers and employees often agree longer notice periods and/or provide that the lack of capability or qualifications; employer can pay an amount in lieu of notice . misconduct; Payment in lieu provisions enable an employer to terminate immediately without breaching the redundancy; contract (thereby retaining the benefit of any the employment could not lawfully be continued; or restrictive covenants), but do have tax disadvantages . Notice periods of between six and some other substantial reason sufficient to justify 12 months are commonplace for senior executives . the dismissal . HERBERT SMITH FREEHILLS Employees 59

Dismissals for certain inadmissible reasons (eg, enhanced redundancy packages over and above the reasons relating to pregnancy or family leave, statutory amount (although there can be age whistleblowing, raising health and safety concerns, discrimination issues depending on the type of asserting certain statutory rights, during official scheme) . The statutory payment is broadly equal to industrial action up to 12 weeks etc . ) are the basic award for unfair dismissal and is set off automatically unfair and do not require any minimum against that award if the redundancy dismissal is period of service . Dismissals for political opinions or unfair . A fair redundancy procedure will involve using affiliations also do not require any minimum period fair selection criteria and applying them fairly, looking of service . A dismissal on certain grounds can also be for alternative jobs, and consulting with the employee . unlawful discrimination (see below) . Where 20 or more redundancies are proposed, there are also obligations to consult collectively – see below . There is a statutory Code of Practice on disciplinary and grievance procedures applicable to misconduct Discrimination and performance dismissals . An unreasonable Under the Equality Act 2010, discrimination because breach of this Code may lead to compensation for a of nine protected characteristics is unlawful in successful Tribunal claim being adjusted up or down relation to recruitment, employment and certain (depending on which party is at fault) by up to 25% . post-employment conduct (eg, in giving references) . The protected characteristics are sex, pregnancy, The most common award by a Tribunal in cases of marital status, race (including colour, nationality, unfair dismissal is compensation, although national or ethnic origins), disability, gender occasionally an employer is ordered to re-employ the reassignment, religion/ belief, sexual orientation and employee . Compensation includes a basic award of age . There is conflicting case law as to whether caste up to£13,920 (as of 6 April 2014) depending on age is included within the protected characteristic of and length of service and a compensatory award to race; the Government has committed to amend the reflect loss, capped at the lower of £76,574 (as of Equality Act to expressly provide for this, expected 6 April 2014) and 52 weeks’ actual gross pay . The by April 2015 . The law prohibits direct discrimination, cap does not apply to dismissals for whistleblowing indirect discrimination (where a practice applied to or raising health and safety concerns . all staff disadvantages a minority group), harassment and victimisation (treating someone less favourably From September 2013 it has been possible to offer because of their involvement in a Tribunal claim) on employment with “employee shareholder” status grounds of an employee’s protected characteristic . whereby individuals receive at least £2,000 worth of Direct discrimination and harassment because an shares (with beneficial tax treatment) in their employee is perceived to have, or is associated with a employer (or a parent company of their employer) in person who has, a protected characteristic is also return for giving up some employment rights, prohibited . Employers can only justify direct including the right to claim unfair dismissal in most discrimination which is on grounds of age (and this cases . Take-up has largely been limited to venture will be rare); objective justification is a potential capital and private equity employers . defence to all forms of indirect discrimination . Retirement at a particular age is now unlawful unless Redundancy objectively justified . Positive discrimination in favour An employee dismissed for redundancy will be of minority groups is unlawful, but limited types of entitled to a statutory redundancy payment if he has positive action can be taken, particularly in relation to two years’ service . Larger employers often provide recruitment and promotion . 60 Employees HERBERT SMITH FREEHILLS

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In relation to disability discrimination, there is a duty to can also award compensation for any personal injury make reasonable adjustments to accommodate a caused . Aggravated damages can also be awarded disabled employee . This duty is quite extensive, eg, in to reflect unacceptable behaviour by the employer some circumstances an employer could be required to eg, in the way the employee is treated after having offer a suitable vacancy to an employee no longer able made a complaint . to do his job or, if its own failure to adjust the workplace means a disabled employee has to take sick leave, to It is also unlawful to treat part-time workers or continue to pay full salary during the sick leave (even if employees on fixed-term contracts less favourably contractually entitled to reduce or cease payment) . because of their part-time or fixed-term status, unless Employers are also prohibited from asking pre-job offer objectively justified . Less favourable treatment on health questions save for limited purposes . grounds of union membership is unlawful and there are also protections for military reservists . Pay secrecy clauses in employment contracts are unenforceable where a disclosure is sought or made Whistleblowing in order to check whether pay discrimination has Changes were made to whistleblowing law from occurred . Regulation is planned in 2014 to give 25 June 2013 . It is unlawful to subject an employee Employment Tribunals the power to order an (or worker) to detriment or dismiss him for making a employer found to have breached equal pay law to protected disclosure, ie, a disclosure which, in the carry out an equal pay audit, expected to come into reasonable belief of the whistleblower, is made in the force in October 2014 . public interest and tends to show, for example, the commission of a criminal offence or a failure to Employers will be liable for their employees’ comply with a legal obligation, a miscarriage of discriminatory conduct unless they can show that justice or danger to the health and safety of any they took reasonable steps to avoid the conduct individual . Employers will be vicariously liable if their occurring . Simply having an equal opportunities employees subject a whistleblower-colleague to policy, without ensuring the workforce is properly detriment, unless they can show that they took all trained on it, will not be enough . reasonable steps to prevent the detrimental treatment . There is no requirement that disclosures The Equality Act has no express provisions setting be made in good faith to be protected, but out when employees working abroad can bring compensation may be reduced by up to 25% for bad discrimination claims in the UK . The position remains faith . Usually a disclosure must be made to the uncertain, but an employee who has done some employer, although there are circumstances where work in the UK is likely to be eligible . Case law has the employee can disclose to a third party, also suggested that employees working in Europe recognised under statute as a “prescribed person” may be able to bring claims here in England if their (this will be less likely if the employer has an internal contract of employment is governed by English law . whistleblowing procedure) . A whistleblowing dismissal is automatically unfair with no minimum There is no statutory limit to the size of service requirement and no cap on the compensation compensation awards for discrimination claims . In that can be awarded . addition to economic loss, Employment Tribunals will usually make an award for injury to feelings (which Bribery Act case law has established should be between £660 and £33,000 (as at March 2014), split into three From July 2011 the Bribery Act 2010 introduced a bands depending on the seriousness of injury) and corporate offence of failure to prevent bribery by HERBERT SMITH FREEHILLS Employees 61

those acting on behalf of a business . UK companies, integrated into the parent company’s business, there and non-UK companies which carry on at least part may be a TUPE transfer at that point) . TUPE applies of their business in the UK, are subject to the offence, to: (i) a business or party situated in the UK prior to and may be found guilty if an employee or third party the transfer, where it retains its identity post-transfer; service provider pays a bribe on the company’s and (ii) an organised grouping of employees in Great behalf . The offence applies even where the bribery Britain whose principal purpose is to carry out a occurred wholly outside the UK and/or the company service for a client (provided the service is not a had no knowledge of the bribery . The offence covers single short-term task nor wholly or mainly for the both the bribery of public officials and private sector supply of goods), where the activities remain (commercial) bribery . Penalties for the company fundamentally the same post-transfer . The include an unlimited fine and confiscation of any Employment Appeal Tribunal has given its opinion benefit obtained as a result of the bribery . A defence that TUPE can apply even if the business or is available to a company if it has put adequate service-provision is transferred outside the EU . procedures in place to prevent bribery, such as an anti-bribery policy and staff training . Where TUPE applies, the protection includes the following . In addition, the Bribery Act creates offences of Trade union or employee representatives must be paying bribes, accepting bribes, and bribing non-UK informed and consulted in advance about the public officials which can be committed both by proposed transfer; if there are no appropriate individuals and corporates (although corporate representatives in place, elections must be held liability would only occur in respect of these latter (save that micro-employers with fewer than 10 offences if a senior member of the corporate was employees can inform and consult directly with the liable for the same offence) . The penalties for these individual employees in respect of transfers on or offences include up to ten years’ imprisonment (for after 31 July 2014); the penalty for failure to inform individuals), an unlimited fine (for the company), and consult is up to 13 weeks’ pay per employee confiscation of the benefit of the crime, and and there may be joint and several liability for both debarment from certain types of public transferor and transferee . sector contracting . The employment contracts of employees in the Employee protection on business transferring business automatically pass to the transfers transferee, save for certain pension rights; TUPE (Transfer of Undertakings (Protection of continuity of service is protected . Employment) Regulations 2006) is the UK version of The transferee inherits accrued rights and liabilities EU rules protecting employees in the event of a in relation to the transferring employees; the transfer of a business or part of a business to another transferor is obliged to provide the transferee with party; minor reforms came into force on 31 January specific information about employment liabilities 2014 . Mergers, outsourcings or insourcings of at least 28 days before the transfer (increased services, changes of contractor providing services, from 14 days for transfers on or after 1 May 2014) . and intra-group transfers can all be covered, depending on the circumstances . It is not possible to Any dismissal where the principal reason is the contract out of TUPE . However, TUPE does not apply transfer will be automatically unfair (although to simple transfers of some assets nor to share sales employees will only be eligible to bring an unfair (although if the subsidiary’s business is subsequently dismissal claim if they have the usual qualifying period of service of two years (or one year where 62 Employees HERBERT SMITH FREEHILLS

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the employment commenced before 6 April 2012), elected employee representatives, starting at least unless the employer can show an economic, 30 days before the first dismissal, and must also technical or organisational reason entailing notify the Government . (The European Court of changes to the workforce (this generally means Justice is due to consider whether the “one that there must be a genuine redundancy situation, establishment” test is incompatible with EU law and can include a place of work redundancy on following an Employment Appeal Tribunal ruling that relocation of the business or service) . the threshold should be applied by considering an employer’s proposed redundancies in aggregate, Changes to the transferring employees’ terms and even where these are spread across a number of conditions will be unenforceable where the separate workplaces or business units .) The 30 day principal reason is the transfer, even if the period is increased to a minimum of 45 days if 100 or employees agree to them; harmonising the more dismissals are proposed (the 45 day period is a newly-acquired workforce’s terms with those of an minimum and employers should continue consulting existing workforce will usually be seen as due to beyond that minimum period where it is necessary to the transfer and ineffective; there is greater do so) . Failure to inform and consult can lead to an flexibility to change terms derived from collective award against the employer of up to 90 days’ pay per agreements and where the transferor is insolvent . employee . Where a TUPE transfer leads to collective Employees have extended rights to resign and redundancies, it is now possible for the transferee to claim unfair dismissal, eg, where a transferee start the redundancy consultation process before the proposed making changes without breaching the transfer with the transferor’s agreement . employees’ contracts but which would involve a substantial change to employees’ working There are also obligations to consult employees in conditions to their material detriment . relation to health and safety matters . Employees can object to the transfer of their Some companies may also have European or employment, which would then terminate on the domestic works councils, which they will be required transfer with no right to compensation; however, to inform and consult about matters that could the enforceability of restrictive covenants may significantly affect employment . As a result, there then be affected . could be obligations to consult at an early stage of many proposed corporate transactions, including These protections increase the importance of share sales . identifying possible TUPE transactions at an early stage, carrying out careful due diligence on human Finally there are obligations to inform and consult resource issues, and negotiating appropriate employee representatives about certain changes to warranties and indemnities to reflect an acceptable pension entitlements, for employers of 50 or more allocation of risk . employees in the UK . Obligations to inform and consult Family friendly leave and pay TUPE transfers are not the only occasion when UK All pregnant employees have a right to paid time off employers are required to inform and consult their for ante-natal care . As of 1 October 2014, fathers and staff . An employer (of whatever size) who proposes partners will also have a right to paid time off to to make redundant 20 or more employees “at one attend up to two ante-natal appointments . establishment” within a period of 90 days must inform and consult with trade union members or HERBERT SMITH FREEHILLS Employees 63

All employees are entitled to 52 weeks’ maternity Other statutory rights leave; those with 26 weeks’ service at the relevant UK employees enjoy a wide range of other statutory time are entitled to statutory maternity pay (90% rights, including the following . pay for the first six weeks followed by 33 weeks at a flat rate of £138 18. per week (as of 6 April 2014)) . Working time rights: employees may not work more than 48 hours a Fathers with 26 weeks’ service are entitled to two week (usually averaged over 17 weeks) unless weeks’ leave paid at the flat rate and currently may they expressly agree to opt out of this or are take additional paternity leave if the mother returns senior employees with autonomous to work during the second six months of her decision-making powers; entitlement . From April 2015 the right to additional paternity leave will be replaced . Instead, for babies records of hours worked must be kept; due on or after 5 April 2015, mother and fathers will minimum rest requirements; and be able to opt to share between them up to 50 of the 52 weeks’ statutory maternity leave and 37 out of 39 additional working hour protections for night weeks’ statutory maternity pay as shared parental workers and workers under 18 years old . leave and pay within the first year after the birth; Employees are entitled to statutory minimum paid parents will be able to take this concurrently and holiday of 5 .6 weeks (including bank potentially in a number of blocks . (public) holidays) . Adopters can currently take leave equivalent to Employees have various time-off rights (eg, for jury maternity and paternity leave but are required to service, etc .), some of which are paid; employees have 26 weeks’ service at the relevant time . of larger employers (at least 250 employees) also Adopters’ pay and leave entitlements will be brought have the right to request unpaid time off for into line with those of birth parents in 2015 . Parents training or study relevant to their work . with one year’s service are entitled to 18 weeks’ Employees are entitled to statutory sick pay unpaid parental leave to be taken before the child is (£87 .55 per week as of 6 April 2014) during sick five years old (on 8 March 2013 this increased from leave for up to 28 weeks during any three 13 weeks’ leave) . year period . From 30 June 2014, the right to request flexible Employees have the right to be paid the national working will be extended to all employees with 26 minimum wage, currently £6 .31 per hour for those weeks’ service (rather than just those with children aged over 21 . This will increase to £6 .50 per hour or caring responsibilities for dependent adults as the on 1 October 2014 . law currently stands) . Employers will have a duty to Pension reforms are being implemented over a five consider requests in a reasonable manner in year period from 1 October 2012 . The two key accordance with a statutory code of practice . elements are: (i) a new requirement on employers to automatically enrol “jobholders” in a workplace All employees have a right to unpaid time off to cope pension scheme that meets certain qualifying with certain incidents involving dependants . criteria; this can either be the employer’s own 64 Employees HERBERT SMITH FREEHILLS

Employees

existing pension scheme or NEST (National REQUIREMENT FOR FOREIGN Employment Savings Trust), the central EMPLOYEES TO OBTAIN PERMISSION government-established scheme, and; (ii) TO WORK mandatory minimum employer pension British citizens, Swiss nationals and nationals of most contributions on behalf of those employees who countries in the EEA do not require permission to join their workplace pension scheme . work in the UK . Employers have various health and safety obligations, including to carry out Non-EEA nationals usually require immigration risk assessments . permission under the new points-based system introduced from 2008 onwards . Tier 1 of the new Employees have rights to privacy and data scheme covers highly skilled workers . Tier 2 replaced protection; particular care needs to be taken when the old work permit scheme . Under Tier 2, an monitoring employees’ e-mail or internet use or employer must be registered as a sponsor and a using CCTV, and it is advisable to put in place migrant must be sponsored by that employer before internal policies to inform employees what they can come to work in the UK . Employers who monitoring is carried out; there are also special negligently hire illegal workers face a fine of up to rules about transferring employee data (which £20,000 (as of 6 April 2014) for each offence and could include accessing data on a global Human those who knowingly hire illegal workers risk an Resources (HR) intranet) to a country outside the unlimited fine and a prison sentence . Further EU . Under UK data protection legislation an information can be found at http://www .bia . employee has the right to make a data subject homeoffice gov. uk/employers/. . access request to their employer in order to request copies of any personal data held about TAX ISSUES them (in the employer’s capacity as a data controller) . There are a number of tax issues that will need to be considered when setting up in the UK – from an Agency workers employer and employee’s perspective . Care must also be taken when using contractors to ensure that Under UK regulations implementing the EU Directive they do not inadvertently become employees . There on temporary agency workers, agency workers are two main issues: income tax and national supplied by an entity to work temporarily under the insurance contributions (NICs) . direction and supervision of a hirer have the right to information about relevant vacancies at the hirer and UK employers are obliged to operate a pay as you to access to collective facilities and amenities earn (PAYE) system of withholding for income tax provided by the hirer (such as access to any due on any remuneration paid to an employee . A UK workplace crèche, car parking etc .) . Further, once an employer for these purposes includes a UK branch or individual has been supplied to a hirer for 12 weeks in office of any overseas business . PAYE must also be a particular role, the agency supplying them is operated for all employees (and directors) who work obliged to provide them with certain pay, terms and under the day to day control and management of a other working conditions at the same level as they business in the UK or a UK branch or office of an would have received had they been directly overseas business . Generally, such entities will be employed by the hirer . required to register with HMRC as an employer before the first payment to an employee/director . HERBERT SMITH FREEHILLS Employees 65

HMRC will assist in providing the relevant guarantee that the employer will offer any work, but registration paperwork . The PAYE position may vary the worker is expected to accept any work offered) . if the individual concerned is not resident, ordinarily A new state-funded health and work service will resident or domiciled in the UK . Employees coming offer occupational health advice on employees off to the UK for short term visits may not be subject to sick for at least four weeks from 2015 . PAYE in the ordinary way if certain conditions are satisfied . Similarly, workers who provide services There are also various EU proposals that may require through an intermediary are also subject to implementation in the UK in due course, eg, relating special rules . to non-EU seasonal workers, posted workers, and trade secrets . UK NICs (similar to social security) are payable by the employee (although collected by the employer) and the employer . Primary Class 1 NICs are payable by employees at the rate of 12% on earnings between £153 and £805 per week and 2% on earnings above £805 per week (as of 6 April 2014) . Secondary Class 1 NICs are payable by employers at the rate of 13 .8% on earnings above £153 per week (as of 6 April 2014) .

Certain salaries are below the NIC threshold and are therefore exempt . Self-employed people are subject to different rules .

Tax consequences for the employee also arise on termination of employment . For example, it is possible in some cases for an employee to receive the first £30,000 of a termination payment free of PAYE and NICs although certain conditions apply .

Tax legislation is complex and specific tax advice should always be sought .

REFORM PROPOSALS In addition to those reforms mentioned above, the Government has plans for reform of sickness absence management, working time, apprenticeships and tax-free childcare . It is also considering further changes to the whistleblowing regime, reviewing regulation of agency workers and the recruitment sector, and has consulted on measures to address the issue of “zero hours” contracts for casual workers (where there is no 66 tax HERBERT SMITH FREEHILLS

13. TAx

The UK now has a very competitive TAX RESIDENCE FOR INDIVIDUALS – A STATUTORY RESIDENCE TEST tax regime – especially for holding The UK has a tax residence test, known as a companies . statutory residence test or SRT, which applies to determine whether or not an individual is UK resident UK tax advice should always be for a particular tax year (6 April to 5 April) . obtained at the earliest stages of a The test is a combination of simple or “conclusive” transaction, investment or tests for residence and non-residence (which include divestment where there is a UK tests for individuals working full time in one jurisdiction and those who spend a very small or very nexus – even if it may appear remote . significant amount of time in the UK) and more The following chapter provides a complex qualitative tests (which require an broad and high level overview of the assessment of both “ties to the UK” and day count to determine whether an individual is resident .) main UK taxes and tax considerations that may arise when This test will be relevant for individuals who spend investing in the UK . time in the UK, move or return to the UK and those who are leaving the UK .

Specific tax rules apply to certain sectors (such as oil RATES OF TAX and gas and financial services) so additional care needs to be taken in those areas . Corporation tax The main rate of corporation tax is currently 21% . For tax purposes, the UK comprises England, Small companies (ie, profits less than £300,000) are Scotland, Wales, Northern Ireland and the UK currently subject to corporation tax at 20% .It is continental shelf . For UK VAT purposes, the Isle of expected that the main rate of corporation tax will be Man is also included . reduced to 20% on 1 April 2015 .

The tax authority in the UK is called HM Revenue & Value added tax (VAT) Customs (HMRC) . Its website is www .hmrc .gov .uk . VAT is a turnover or consumption tax . Broadly, UK A company will generally be UK tax resident if it VAT is charged on the supplies of most goods and is either: services within the UK and on occasion, supplies made from outside the UK to customers based in the incorporated in the UK; or UK . Complex rules govern the VAT treatment of supplies of goods and services into and out of the UK . centrally managed and controlled in the UK; and not resident in another jurisdiction under a relevant The current standard rate of VAT is 20% . Some double tax treaty . supplies of goods and services are zero-rated (for example, books), some are subject to a reduced rate A UK resident company is subject to UK tax on its of VAT (5%) and some are exempt (such as financial worldwide income, profits and gains whether or not services) . It is intended that the VAT burden is borne those profits are brought into the UK . by the final consumer . HERBERT SMITH FREEHILLS tax 67

Most businesses in the UK will be able to offset any acquisition of commercial land; VAT they pay (called input VAT) in the course of Up to 7% of the chargeable consideration paid for making their supplies of goods or services against the acquisition of certain types of residential real the VAT they charge their customers (output VAT) . estate where the chargeable consideration is over £2 million; Businesses engaged in making exempt supplies, such as banking or insurance services, cannot generally Up to 15% of the chargeable consideration paid for offset their input VAT against their output VAT because the acquisition of residential real estate where: (a) they do not charge VAT on the supplies they make . the chargeable consideration is over £500,000; and (b) where the acquisition is made by a Stamp duty or Stamp Duty Reserve Tax non-natural person such as a company . (SDRT) This must be paid on transfers of shares and certain There are certain reliefs and exemptions from the tax securities . The standard rate of stamp duty is 0 .5% . including group relief . There are certain reliefs and exemptions from the duty/tax including group relief . Individuals The income tax year commences on 6 April each SDRT is applied on agreements to transfer year . For most employed individuals, it is collected chargeable securities for a consideration in money or through the PAYE system money’s worth . It applies whatever the residence of the parties and wherever the agreement is entered Income tax rates. The income tax bands/thresholds into . In practice, a charge to SDRT will most applicable as at 6 April 2014 are as follows: frequently arise, amongst other examples, where a person transfers chargeable securities in Personal allowance (0%): £0 – £10,000 uncertificated form within an electronic transfer Basic rate (20%): £10,001 – £41,865 system (for example, CREST) . SDRT can apply at up to 1 .5% (ie, where the securities are transferred into Higher rate (40%): £41,866 – £150,000 the depositary or clearance system other than when Additional rate (45%): over £150,000 transferred as an integral part of a raising of capital) . There is no relief from SDRT for With effect from 6 April 2015, the bands/thresholds intra-group transactions . are expected to be as follows:

Stamp duty land tax (SDLT) Personal allowance (0%): £0 – £10,500 SDLT is a tax paid on acquisitions (including Basic rate (20%): £10,501 – £42,285 assignments and transfers) of UK land or in some Higher rate (40%): £42,286 – £150,000 (limited) cases, acquisitions of certain partnership interests . The current rates of SDLT are: Additional rate (45%): over £150,000

1% of the net present value of the rental element of Dividend tax rates. The rates of tax applicable to the lease transactions over and above a £150,000 receipt of dividend income for the tax year threshold (which is only given once in any given commencing 6 April 2014 are: transaction or linked transaction); Dividend income at or below the basic rate tax Up to 4% of chargeable consideration paid for the limit: 10% (0%) 68 tax HERBERT SMITH FREEHILLS

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Dividend income at or below the higher rate tax Business rates limit: 32 .5% (25%) Landowners must pay business rates in respect of Dividend income above the higher rate tax limit: non-domestic premises . Business rates are usually 37 .5% (30 .56%) an allowable deduction when calculating profits for corporation tax The brackets denote the effective tax rate, taking into account a tax credit which is available to UK resident TAXATION OF NON-RESIDENT taxpayers on most dividends . COMPANIES Non-resident companies with a permanent National insurance contributions (NICs). Primary establishment in the UK are liable for corporation Class 1 NICs are currently payable at 12% on tax on: earnings between the primary threshold and the upper earnings limit (ie, between £153 per week and income profits of that establishment; and £805 per week) and at 2% on earnings above the gains from the disposal of assets situated in the UK, upper earnings limit (ie, earnings over £817 a week) . which are used in the trade of the establishment .

Secondary Class 1 contributions (paid by the Non-resident companies that do not trade through a employer) are currently payable at 13 .8% on permanent establishment must pay income tax on earnings above the secondary threshold (ie, £153 income arising in the UK (including rents from per week) . UK property) .

The Class 1 Upper Earnings Limit (above which DIVIDENDS/INTEREST/ROYALTIES employees pay NICs at 2%) is aligned with the point at which higher rate tax becomes payable, Dividends paid by UK companies to foreign ie, £41,866 . corporate shareholders . The UK does not currently impose withholding taxes on dividends paid to The Government had previously planned to consult foreign corporate shareholders by a UK company . on the integration of income tax and NICs . It is not Dividends received by UK companies from foreign clear when or whether this consultation will companies . A UK company will not normally pay go ahead . corporation tax on the receipt of a dividend from a UK or non-UK company, but certain conditions Capital gains tax (CGT). UK resident individuals pay must be satisfied . CGT on the disposal of certain assets at a rate of 18% or 28% (for higher and additional rate taxpayers) . Interest paid to foreign corporate shareholders . A Entrepreneurs’ Relief may be available on the withholding tax of 20% applies to certain interest disposal of certain business assets (including payments to foreign shareholders unless a disposals of shareholdings in trading companies), direction to pay gross or deduct a lower which may reduce the effective rate of tax to 10%, percentage under a double tax treaty is obtained subject to a number of conditions being satisfied . from HMRC . Entrepreneurs’ Relief is subject to a lifetime limit of Intellectual Property (IP) royalties paid to foreign £10 million . corporate shareholders . A withholding tax of 20% HERBERT SMITH FREEHILLS tax 69

applies to certain patent royalties and annual holder in those territories . The Government has payments to foreign shareholders, subject to any confirmed that a UK Patent Box company could, for direction to pay gross or deduct a lower example, own the exclusive UK or other single percentage under a double tax treaty . Member State rights to exploit a patent while the rights to other territories are held by In some cases EU rules prevent withholding . other companies .

Patent Box regime Only certain kinds of patent related income will fall The UK offers a tax incentive to encourage within the Patent Box, and will include, by way investment and growth in the UK by incentivising of example: companies to locate high-value jobs and activities the worldwide income earned by UK businesses associated with the development, manufacture and from inventions covered by a qualifying patent, exploitation of patented technology in the UK (the (thereby avoiding the need for companies to track Patent Box regime) . This regime broadly provides for sales made in each jurisdiction separately); an effective 10% rate of corporation tax for profits attributable to qualifying patents and certain other licence and royalty income relating to qualifying IP; types of IP) . income from the sale of a patented process;

Qualifying patents for these purposes include: income derived from the sale of products incorporating a patented process; Patents granted under the UK Patents Act 1977 and the European Patent Convention; and income embedded in patented products including sales of spare parts for a patented product; National patents granted by Austria, Bulgaria, Czech Republic, Denmark, Estonia, Finland, Germany, income from the sale of patents; and Hungary, Poland, Portugal, Romania, Slovakia, and infringement income (damages or account Sweden (on the basis that such Member States have of profits) . comparable patentability criteria and search and examination practices to the UK) . Examples of income falling outside the Patent Box include: Broadly, in order for IP rights which are within the regime to be qualifying IP, the claimant company (or, profits derived prior to the date that the application in certain circumstances, a member of its group) for the patent is made; must have created or developed the IP . This is known income arising from financial arrangements, as the development condition . including interest and interest equivalents (such as amounts relating to credit for the sale of Claimants must be companies within the scope of products); and UK corporation tax and either hold qualifying IP or an exclusive licence over qualifying IP . For these income from patented inventions which are not purposes, an exclusive licence is broadly a licence actually incorporated into the products sold . which confers rights on the licence holder to the exclusion of all other persons in one or more Complex rules govern the calculation of the Patent territories who carry on a similar trade to the licence Box income . 70 tax HERBERT SMITH FREEHILLS

TAX

RESEARCH AND DEVELOPMENT (R&D) arrangement seeks to exploit any shortcomings of TAX CREDITS the legislation) . The Finance Act 2013 introduced an “above the line” credit which is equal to 10% of a company’s eligible The definition of tax advantage is very wide . R&D revenue expenditure (49% in the case of “ring However, determining whether or not a tax fenced” oil and gas trades) . The credit will be payable arrangement is abusive requires a careful in cash to companies with no corporation tax liability . assessment of the facts . The legislation includes indicators of “non-abusive indicators” including whether arrangement accord with established Companies can also (for a limited period of time) practice and whether HMRC has previously obtain enhanced relief for qualifying expenditure on accepted the practice . R&D activities (under the regime which existed pre-Finance Act 2013) . Large companies may claim a deduction of 130% and small and medium sized If HMRC considers the GAAR should apply it may companies 225% . This is being phased out and will counteract the abusive tax arrangement by making not be available post-1 April 2016 . In the meantime, “just and reasonable” adjustments . If the taxpayer transitional rules apply which give taxpayers a choice does not agree with this assessment, it may request between the above the line credit and enhanced relief a review by the GAAR panel (an independent body (though once the above the line credit is claimed the consisting of HMRC employees and independent enhanced relief will cease to be available) . tax professionals) who will consider written representations of both parties and then issue an GENERAL ANTI-ABUSE RULE (GAAR) opinion (which although not legally binding on either party would be admissible in any subsequent The UK has a GAAR (which may impact on tax tribunal proceedings) . transactions occurring on or after 17 July 2013) . It applies to income tax, corporation tax, CGT, HMRC has published extensive guidance to assist petroleum revenue tax, inheritance tax, SDLT, and with the interpretation of the GAAR . The GAAR annual tax on enveloped dwellings (ATED) . In due panel is responsible for updating this guidance which course, it will also apply to NICs . over time (together with the published GAAR panel opinions) should give more certainty as to when and In summary the GAAR applies to “tax arrangements” how the GAAR may be applied . which are abusive . It should not affect normal commercial arrangements . CONTROLLED FOREIGN COMPANY RULES (CFC) Arrangements are tax arrangements if, having regard The CFC rules are a complex set of tax to all the circumstances, it would be reasonable to anti-avoidance rules the essence of which is to treat conclude that obtaining a tax advantage was the as taxable in the UK some or all of the profits derived main purpose or one of the main purposes of the by a company resident in a foreign jurisdiction (more arrangements . Tax arrangements are abusive if they frequently than not, a tax haven) which is controlled are arrangements the entering into or carrying out of by a UK parent . which cannot reasonably be regarded as a reasonable course of action having regard to all the The rules were previously notorious for their circumstances (including the policy behind the complexity . However, following extensive legislation, whether the arrangement includes consultations a new regime was introduced artificial or contrived steps and whether the HERBERT SMITH FREEHILLS tax 71

for accounting periods beginning on or after TRANSFER PRICING RULES 1 January 2013 . Transfer pricing rules provide that transactions between UK companies and UK or foreign affiliates The CFC rules will be of interest to groups that set up must be taxed on the arm’s length value of the UK holding structures under which the foreign transaction . These rules apply where any of the subsidiaries derive investment or trading income – following apply: particularly if that investment or trading income has a UK source . the UK company has overall control of the foreign or UK affiliate; The new rules are widely acknowledged to be far the UK company holds at least 40% of the more targeted and appropriate to ensure that only affiliate’s share capital and another entity also income that is artificially diverted from the UK is holds at least 40%; or brought within the charge . a number of persons act together in relation to the DEBT CAP RULES financing arrangements of a business where These very complicated rules can operate to restrict collectively those persons would be capable of the deductibility of UK interest expense where the controlling the company if all their actual or UK entity (or UK part of the worldwide group) has potential rights and powers were aggregated . more debt than the external debt costs of the whole of the worldwide group . The aim is to stop large In certain cases, the transfer pricing rules do not multi-national groups flooding the UK with debt to apply to small and medium sized enterprises . ensure interest deductions are obtained in the UK . The UK is actively involved in the Organisation for These rules operate in addition to the transfer pricing economic Co-operation and Development’s rules and other anti-avoidance rules . The rules took (OECD) Base Erosion and Profit Shifting (BEPS) effect on 1 January 2010 . project which contains significant proposals for the reform of international tax and transfer pricing For companies that fail the gateway test (intended to rules . The aim of the BEPS project is to ensure that exclude most groups), any UK deduction for interest profits and taxing rights should be linked to will, very broadly, be capped at the level of the economic substance and therefore to minimise worldwide debt costs assessed using the consolidated opportunities to take advantage of mismatches in accounts of the group prepared in accordance with the tax rules of different jurisdictions . Further International Accounting Standards (IAS) . legislation in this area is expected . IMPORTS AND EXPORTS The rules only apply to large groups ie, a group at least one member of which is not a company with The taxation relating to UK imports and exports fewer than 250 employees and with a turnover of depends on whether goods are imported or exported less than €50 million or less than €43 million in within the EU or outside it . gross assets . OUTSIDE THE EU A number of anti-avoidance rules operate within the Exports of goods outside the EU are subject to VAT debt cap rules . but are generally zero-rated . Imports from outside 72 tax HERBERT SMITH FREEHILLS

TAX

the EU are subject to VAT, which is payable by the importer at the same rate as if the goods were supplied within the UK . Customs duty and excise duty may also be payable on imports .

WITHIN THE EU The supply of goods between VAT registered traders is generally zero-rated (to qualify, the customer state code and VAT registration number must be put on the invoice) . Where VAT is payable, the customer receiving supplies must pay VAT at his country’s rate . On sales to non-VAT registered customers, the trader generally charges the domestic VAT that would be charged on a domestic sale . Where distance selling rules apply (ie, where the trader has a mail order or internet business) the trader must charge VAT at the rate applicable to its customer’s country .

The supplies of services are treated differently . With a few notable exceptions, since 1 January 2010, the place of supply for VAT purposes for a business to business (B2B) supply of services will be where the customer is based . This generally dictates what rate of VAT is due but also triggers requirements to register for VAT in a jurisdiction, so early advice should be sought .

DOUBLE TAX TREATY NETWORK The UK has one of the largest double tax treaty networks in the world and has treaties with over 120 countries, including the USA, China and nearly all of Europe .

THE TAXATION OF INCOME FROM UK REAL ESTATE Please refer to Chapter 23 below . HERBERT SMITH FREEHILLS Intellectual property 73

14. Intellectual property

When acquiring a business, be capable of industrial application; and intellectual property rights may be not be specifically excluded by statute . important assets of that business . All The patent holder can: the intellectual property rights enjoy exclusive use of the invention within the UK; referred to here can be assigned, prevent the unlicensed manufacture, use, licensed in whole or in part or have importation or sale of the patented invention; charges taken over them . The develop a business based on the invention; and following is an outline of the main license the patent to another party . intellectual property rights that are capable of protection in the UK . How it is protected Applications for registration can be made via the UK It does not cover EU wide rights which have effect in Intellectual Property Office or via the European the UK but are EU wide rights valid over the whole of Patent Office (where a centralised prosecution the EU at once, such as Community trade marks, system operates from which the patent is then Community registered designs and Community translated into a bundle of national rights) . The unregistered design . A unitary patent right will Patents Acts 1977 (as amended by the Patents Act become available across 25 of the 28 EU Member 2004) governs patent protection in the UK . States once the Unified Patent Court Agreement comes into force (expected early 2016) . How it is enforced UK and European (UK) patents are generally The Government has confirmed that it will introduce an enforced through the UK courts . The main remedies effective 10% rate of corporation tax for profits the courts can grant are: attributable to qualifying patents and certain other types of intellectual property (the Patent Box regime) . permanent or interim injunctions; The Patent Box regime contributes to the UK delivery of the infringing articles to the right Government’s intended competitive tax system and will owner; and incentivise companies to locate development, manufacture and exploitation of patented technology in damages or an account of profits . the UK (see Chapter 13 above) . The Patent Box regime is being phased in over five years (starting from 1 April Criminal sanctions are also available . 2013, with 100% application by April 2017) . Length of protection PATENTS Subject to certain exceptions (eg, a Supplementary Nature of the right Protection Certificate can extend the length of To be patentable, an invention must: protection of a patented pharmaceutical product in some cases), protection lasts for a maximum of be new; 20 years provided that renewal fees are paid annually involve an inventive step; from the fifth year after filing . 74 Intellectual property HERBERT SMITH FREEHILLS

Intellectual property

TRADE MARKS REGISTERED DESIGNS Nature of the right Nature of the right To be registered as a trade mark, a sign must: To qualify for registration, a design must: be capable of graphical representation; and be new; distinguish the goods or services of one have individual character; and undertaking from another . relate to the appearance of all or part of a product resulting from certain features of that product or The trade mark holder can: its ornamentation . enjoy the exclusive right to use the trade mark in the UK; The holder of a UK registered design can: prevent others from using a mark enjoy the exclusive right in the UK to make, import, export, use or stock any product to which the which is the same as (or confusingly similar to) design has been applied or in which it his mark; or is incorporated; which takes unfair advantage of, or is detrimental let others use the design; to the distinctive character or the repute of the trade mark; and prevent others from using the design; and assign or license the use of the mark to assign or license the right to other parties . other parties . How it is protected How it is protected Applications for registration must be made to the UK Applications for registration must be made to the UK Intellectual Property Office . The Registered Designs Intellectual Property Office . Unregistered marks can Act 1949 (as amended) sets out the rules on also be protected through a common law action for protection . It is also possible to register EU-wide passing off . EU-wide trademarks are also registrable registered design rights (Community Registered (Community Trade Marks) and can be applied for Designs) (for which the qualifications are slightly through the European Office for Harmonisation in different) which thereby also cover designs in the UK . the Internal Market (OHIM) . How it is enforced How it is enforced The enforcement procedure and the main remedies The Trade Marks Act 1994 sets out methods of available are similar to those for patents . enforcement . The enforcement procedure and the main remedies available are similar to those Length of protection for patents . Protection lasts for a maximum of 25 years subject to payment of renewal fees every five years . Length of protection Protection lasts indefinitely, subject to payment of renewal fees every 10 years . HERBERT SMITH FREEHILLS Intellectual property 75

UNREGISTERED DESIGNS music; Nature of the right sound recordings; D films; The design must: broadcasts; and relate to an aspect of shape or configuration of the cable programmes . whole or part of an article; and not be commonplace . The owner of the copyright in a work has the exclusive right to do the following acts in the UK: The holder of a UK unregistered design can: copy the work; enjoy the exclusive right to reproduce the design issue copies of the work to the public; for commercial purposes by making articles to that design or by making a design document recording rent or lend the work to the public; the design for the purpose of enabling the articles perform, show or play the work in public; to be made; communicate the work to the public; and prevent others from infringing his right; and make an adaptation of the work or do any of the assign or license the right to other parties . above in relation to an adaptation .

How it is protected The right holder also has the right to: A design is automatically protected provided that it is prevent others from infringing any of his rights; and recorded in a tangible form such as a diagram . It is also possible to have automatic protection under assign or license the rights to other parties . Community unregistered design for which the qualifications are slightly different and registration is The creator of the copyright work (whether or not he not necessary but protection lasts for only three years . is the right holder) also has the right to: be identified as the author or director of the work How it is enforced (if he asserts that right); The enforcement procedure and the main remedies object to derogatory treatment of the work; available are similar to those for patents . not have work falsely attributed to him . Length of protection These rights can be waived by the creator . Protection lasts for a maximum of 15 years from the end of the year in which the design was created . How it is protected COPYRIGHT Protection subsists automatically when the work is Nature of the right created . The rules on protection are set out in the Copyright, Designs and Patents Act 1988 . Copyright subsists in the following original works: How it is enforced literary (including software); The enforcement procedure and the main remedies drama; available are the same as those for patents, except 76 Intellectual property HERBERT SMITH FREEHILLS

Intellectual property

that additional damages are also available for Length of protection flagrant copyright infringement . There is no fixed term, although the information Length of protection must remain confidential for it to be protected . The length of protection depends on the work: literary, dramatic, musical and artistic works: 70 years after the author’s death; films: 70 years after the death of the last surviving director, author of the screenplay, or composer of any music specifically created for the film; sound recordings: 70 years from the year of publication (and also 70 years for the protection of the performers’ rights); broadcasts: 50 years from the first broadcast; and published editions: 25 years from the first publication .

CONFIDENTIAL INFORMATION Nature of the right The right is based on common law principles . The information must be: confidential in nature; and communicated in circumstances importing an obligation of confidence .

The right holder can take legal action against any party who is under a duty of confidence to the right holder with regards to the confidential information .

How it is protected A court action for breach of confidence would be based on breach of contract or equity .

How it is enforced The same applies as for patents, except only damages are available . HERBERT SMITH FREEHILLS COMMERCIAL AGREEMENTS 77

15. COMMERCIAL AGREEMENTS

Standard commercial contracts that the scope of the Chapter I prohibition/Article 101 TFEU, and if they do, whether they meet the investors in the UK will need to conditions for exemption . The EU Commission has become familiar with include adopted block exemption regulations for the most distribution, franchising and agency common types of agreements, which provide a safe harbour for those agreements which comply with the arrangements, the regulation of conditions set out in the block exemption . which is discussed here . Agreements which are exempt from Article 101(1) TFEU by virtue of an EU block exemption regulation DISTRIBUTION benefit from a parallel exemption under UK competition law and are therefore also exempt from There are no specific regulations relating to the Chapter I prohibition . distribution agreements in the UK, and so these arrangements are regulated by generally applicable For distribution agreements, the relevant block law . Two areas are worth noting: exemption regulation is Regulation 330/2010, which is the block exemption for vertical agreements, and PRODUCT LIABILITY the accompanying Guidelines on Vertical Restraints . Suppliers should be aware of the extent of their The safe harbour of this block exemption Regulation product liability under product liability legislation, will generally be available provided three conditions including the Consumer Protection Act 1987 . are met: both the supplier’s and the buyer’s market Essentially, a supplier may be liable to the ultimate share threshold on the relevant market is below consumer for the products it supplies to a distributor, 30%, the agreement does not contain any hardcore despite having no direct contractual relationship with restrictions and any impermissible (but that consumer (see Chapter 18 below) . non-hardcore) restrictions must be severable from the rest of the agreement . COMPETITION LAW ISSUES Parties entering into distribution arrangements The hardcore restrictions are listed in Article 4 of the should also be aware of competition law issues, in block exemption Regulation and they include: particular the application of the Chapter I prohibition resale price maintenance; of the UK Competition Act 1998 and Article 101 of the Treaty on the Functioning of the European Union territorial restrictions or restrictions on resale (TFEU) . Although vertical agreements (distribution, to customers; supply, purchasing, agency, franchise agreements) certain restrictions on resale in a selective are generally viewed by the competition authorities distribution system; as less problematic than horizontal agreements (typically agreements between competitors), they restrictions on cross-supplies in a selective nevertheless have the potential to infringe the distribution system; and competition rules as they can lead to foreclosure or a certain restrictions on the supply of spare parts . reduction in intra-brand competition . The impermissible restrictions are set out in Article 5 Both under EU and UK competition law parties to an of the block exemption Regulation and mostly relate agreement must conduct a self-assessment in order to certain types of non-compete provisions . As long to determine whether their agreements fall within as those restrictions are severable, the rest of the 78 COMMERCIAL AGREEMENTS HERBERT SMITH FREEHILLS

COMMERCIAL AGREEMENTS

agreement will continue to benefit from the block EUROPEAN CODE OF ETHICS exemption Regulation . FOR FRANCHISING There is also a European Code of Ethics for The Guidelines provide a more detailed explanation Franchising (the ECEF) with which members of the of some of the provisions in the Regulation, as well as British Franchise Association (and other bodies that guidance on the analysis of vertical agreements that are part of the European Franchise Federation) must fall outside the scope of the block exemption comply . In the United Kingdom, membership of the Regulation (Guidelines on Vertical Restraints, Official British Franchise Association is voluntary; Journal C130 of 19 .5 .2010) . There is also a section non-members are therefore not required to comply that deals with the treatment of online sales . The EU with the ECEF . In brief, the ECEF requires a franchisor: Commission is very keen on promoting online sales (i) to have operated a pilot operation previously, throughout the EU and there will only be very limited (ii) to own all the brand names and trademarks circumstances where an outright ban on online sales associated with the franchise; and (iii) to provide (or provisions with similar effect) will fall outside the initial and continuing training to franchisees . scope of Article 101/Chapter I prohibition . AGENCY FRANCHISING Aside from generally applicable laws, the key specific There are no specific laws relating to franchising in regulations to be aware of when entering into agency the UK, and so the general law will apply . However, agreements (in relation to goods) as part of business certain types of franchise which involve more than operations in Great Britain are the Commercial one tier of franchisees will be caught by the Trading Agents (Council Directive) Regulations 1993 (the Schemes Regulations 1997 and the Trading Schemes Commercial Agents Regulations) . (Separate, but (Exclusions) Regulations 1997, both made under the identical, regulations apply in Northern Ireland .) Fair Trading Act 1973 (as amended by the Trading Schemes Act 1996) . These regulations: APPLICATION restrict the content of advertisements promoting The Commercial Agents Regulations apply to trading schemes; arrangements involving a self-employed require the grant to new franchisees of a 14 day intermediary with continuing authority to negotiate cooling off period prior to arrangements with the sale or purchase of goods on behalf of, and in the franchisors becoming legally binding; and name of, a principal . Note that there is a very wide interpretation of negotiate, and the agent does not, require franchise agreements to include for example, have to have authority to vary the price certain warnings . or other contract terms . For the Commercial Agents Regulations to apply, the agent’s activities must be COMPETITION LAW ISSUES undertaken in Great Britain, or the agency agreement The competition law points mentioned above in must be governed by English law (if the activities are relation to distribution arrangements will also apply to be undertaken elsewhere in the EEA, and the to franchising arrangements . corresponding regulations in that Member State permit the parties to agree that the law of another Member State can apply to the agency agreement) . HERBERT SMITH FREEHILLS COMMERCIAL AGREEMENTS 79

The Commercial Agents Regulations will not apply if on behalf of the principal for the purchase or supply the parties have agreed that the agency agreement of goods or services . Whether or not an arrangement will be governed by the law of another EEA Member is a “true agency” arrangement for the purpose of State, but the corresponding regulations of that state competition law is a matter of substance, not form . A will apply . The Commercial Agents Regulations may determining factor in assessing the agency also apply even if the principal is outside the EEA and arrangement is the level of financial or commercial the parties have chosen the law of a non-EEA state . risk assumed by the agent . Activities undertaken outside the EEA are very unlikely to be caught by the Commercial Agents An agency will fall outside these competition Regulations, even if the contract is governed by provisions if the agent bears no, or only insignificant, English law . risks . The question of risk is determined on a case by case basis and with respect to the economic reality The Commercial Agents Regulations do not apply in of the circumstances rather than any specific certain circumstances (eg, where the agent’s legal form . activities are considered secondary), and so specific legal advice should be sought . A distributorship (see TAX ISSUES above) will fall outside the scope of the Commercial There are a number of tax issues (including VAT) Agents Regulations as there is no direct contractual which need to be considered when commercial sales link between the principal and the customer . agreements are considered . The tax risks and opportunities will depend on, among other things, EFFECT the jurisdiction of the parties, the type of services or The Commercial Agents Regulations prescribe goods provided, where the services/goods are minimum terms which will apply to all agency provided and the nature and legal status of agreements, in relation to notice periods, timing for the parties . payment of commission and agents’ rights to information, for example . A key provision is the right of an agent to compensation or an indemnity from the principal on expiry/termination of the agreement . If the agreement is silent, compensation rather than an indemnity will apply . The compensation payable may be up to the whole value of the agency business as at the date of termination whereas an indemnity is capped at one year’s gross commission . It is advisable to seek specific advice in this area, as different considerations apply to each of the compensation and indemnity amounts, and the level of an agent’s entitlement in this regard .

COMPETITION LAW ISSUES The Chapter I prohibition and Article 101 provisions referred to in the section on distribution above do not apply to “true agency” agreements, where one party (principal) appoints another (agent) as a negotiator 80 E-COMMERCE HERBERT SMITH FREEHILLS

16. E-COMMERCE

The sale of goods and services at a applies to clauses in contracts which seek to exclude or limit liability, providing that certain distance, whether online via exclusions or limitations of liability are wholly computer, mobile phone or other ineffective . For example, a term seeking to exclude electronic device is a large part of or limit the supplier’s liability for death or personal injury caused by negligence will be wholly many businesses . However, this ineffective and unenforceable . growth in e-Commerce has also The Unfair Terms in Consumer Contracts resulted in the development of Regulations 1999 (UTCCR) also apply to any term associated e-Commerce of a contract entered into with a consumer which regulations which investors in this has not been individually negotiated . Any such term considered to be unfair (ie, if the term, type of business will need to contrary to the requirement of good faith, causes a consider . Due to the changing significant imbalance in the parties’ rights and nature of technologies, legislation in obligations arising under the contract, to the detriment of the consumer) will be unenforceable this area has developed in a as against the consumer . fragmented manner . Terms being implied into contracts Broadly speaking, there are two categories of The Sale of Goods Act 1979 (SGA) applies to all regulation affecting e-Commerce: sale of goods contracts . The Act implies a number general consumer protection legislation; and of terms into sale of goods contracts, particularly in relation to title and quality . For example, it will be specific e-Commerce legislation . implied that the goods are of satisfactory quality and that the seller has the right to sell them . Key regulatory issues relating to each of these categories are set out below . The UK is currently undergoing a review of consumer law in order to reform and consolidate much of the GENERAL CONSUMER PROTECTION law in this area . The proposed Consumer Rights Bill LEGISLATION is not yet in force, but once implemented, it will Suppliers providing goods or services to consumers consolidate a large part of consumer law in the UK in the UK will need to comply with applicable including the rights and remedies for goods and consumer protection legislation . This type of services, rights in respect of digital content and unfair legislation is mandatory and cannot be overridden consumer terms . merely by including contract terms that specify that the laws (and courts) of a different country will apply . The key areas of reform tackled by the Consumer Current consumer protection legislation can result, Rights Bill include: inter alia, in: Digital content: The Consumer Rights Bill applies Express terms in contracts being unenforceable to digital content, which includes downloadable by suppliers content, computer games and mobile apps . Digital content must comply with the same provisions as The Unfair Contract Terms Act 1977 (UCTA) goods . If digital content is defective, consumers HERBERT SMITH FREEHILLS E-COMMERCE 81

will have a right to have such content repaired or contract) . The Consumer Contracts Regulations replaced or be entitled to receive a reduction have extended the list of pre-contract information in price . that businesses must disclose in respect of “distance contracts” and “off-premises” contracts Unfair terms: The Consumer Rights Bill and also included an obligation for suppliers to consolidates the law on unfair terms in consumer make a model cancellation form available contracts, which sets out a list of terms which to consumers . consumers may find unfair . Consumer contracts must contain terms which are transparent, legible Costs and payments and written in plain and intelligible language . Under the Consumer Contracts Regulations, the Fairness: All consumer contracts will be assessed supplier must provide clear information regarding for fairness and courts will have a duty, even if a all costs, including potential ones the consumer consumer has not raised this in the complaint, to may incur in the future . If the supplier cannot give a consider fairness . firm cost upfront, it must show on what basis the SPECIFIC E-COMMERCE LEGISLATION final cost will be calculated . With regard to returns, the supplier must make clear that the consumer The legislation regulating e-Commerce in the UK is must pay for returns if they cancel, unless the largely derived from European directives . The most supplier is willing to pay for that cost . For online important pieces of legislation in the UK to sales, the consumer must explicitly acknowledge understand in this context are: (i) the Electronic any obligation to pay (eg, by clicking on a button Commerce (EC Directive) Regulations 2002 that says “pay now”) . The supplier must also make (e-Commerce Regulations); and (ii) the new sure that any additional payments are not a default Consumer Contracts (Information, Cancellation and option which the consumer has to take action to Additional Charges) Regulations 2013 (Consumer avoid (eg, pre-tick boxes which the consumer has Contracts Regulations) which apply to distance to untick to avoid a charge) . selling and replaced the regulations previously known as the Distance Selling Regulations . The Cancellation rights and refunds Consumer Contracts Regulations represent the UK’s implementation of certain provisions of the EU The Consumer Contracts Regulations provide Consumer Rights Directive, and apply to distance consumers with a cooling-off period when contracts made on or after 13 June 2014 . purchasing goods or services at a distance This right allows consumers to cancel a contract within Key regulatory issues arising from this legislation 14 working days, without penalty and without include, inter alia, the following: giving any reasons, even where there is no fault in the goods or services . If the business fails to Provision of information provide certain pre-contract information (as Both the e-Commerce Regulations and the discussed above), the cooling-off period can be Consumer Contracts Regulations require suppliers extended (subject to certain exceptions) even to provide certain basic information to their further to 12 months . Upon cancellation, customers . This includes: (i) company information consumers are also entitled to a full refund . The (eg, name, postal address, registered office and supplier must refund the consumer within 14 days email address); and (ii) contractual information of receiving the goods back or proof of the return of (eg, the technical steps involved in completing the the goods if that is earlier . The refund should include the cost of outbound delivery (provided the 82 E-COMMERCE HERBERT SMITH FREEHILLS

E-COMMERCE

standard delivery option was used), but need not about whether it applied to online auction sites . As include the cost of the return delivery to the such, operators of online auction platforms may supplier unless the supplier offered to bear this or have to re-evaluate some of their practices . did not tell the consumer that they would have to . ONLINE MARKETING AND Digital content ADVERTISING Under the Consumer Contracts Regulations, The e-Commerce Regulations specify certain rules in provision of digital content (eg, a music download) relation to the use of email and text messaging for is treated as a new type of supply, which is marketing purposes (eg, the email or text message distinguished from the supply of goods and/or must clearly identify the person on whose behalf the services . Businesses must comply with message is sent) . Unsolicited commercial digital-specific information requirements (for communications sent by email must also be clearly example, details of functionality) . However, and unambiguously identifiable as such . However, consumers will not have a right to cancel once a the UK’s main piece of legislation dealing with download has started, provided the supplier has electronic marketing is the Privacy and Electronic told them this and obtained their Communications (EC Directive) Regulations 2003 explicit acknowledgement . (as amended) (the ePrivacy Regulations) . The ePrivacy Regulations require prior consent for the Liability of intermediaries sending of unsolicited commercial emails to individuals (although not for the sending of such The e-Commerce Regulations provide a defence emails to corporates) . Since 2011, the use of tracking for service providers acting as ISPs (internet software (eg, cookies) by websites also requires the service providers), network operators or website consent of the website user . hosts against liability for information that they transmit, cache or host . Generally speaking, these intermediaries will not be liable for such information provided that certain conditions are satisfied . It is worth noting that the EU e-Commerce Directive prohibits Member States from imposing a general obligation on intermediaries to monitor the information that they transmit, cache or host . The UK e-Commerce Regulations do not include this prohibition but the UK courts must have regard to the Directive in any case before them .

Online auctions

Online auction sites are now clearly covered by the Consumer Contract Regulations, whereas the legislation in place prior to the Consumer Contract Regulations coming into force was ambiguous HERBERT SMITH FREEHILLS PRIVACY AND DATA PROTECTION 83

17. PRIVACY AND DATA PROTECTION

The explosion of data use worldwide, a developing common law of personal privacy (described as the tort of misuse of private together with the advent of new information per Nicholls LJ in Campbell v MGN Ltd technologies making the transfer and [2005] UKHL 61) . disclosure of personal data ever Whilst these privacy rights should not be disregarded, easier, has resulted in a changing it is the data protection regulatory regime that public perception of the need for probably has the greatest day-to-day impact on data protection regulation . The data organisations conducting business in the UK . protection rules in the UK derive The DPA regulates the processing of personal data, from the European Data Protection which is data relating to living individuals who can be identified . The DPA requires that a data controller Directive, known to provide some of (generally speaking, being the entity responsible for the most stringent data protection collecting and using the personal data): obligations in the world . Data registers with the Information Commissioner’s protection compliance is therefore an Office describing the data it processes and the purposes of such processing (breach of this important part of each and every requirement is a criminal offence); and business in the UK . complies with the eight Data Protection Principles set out in Schedule 1 of the DPA, which include: THE REGULATORY FRAMEWORK (i) ensuring that data is up to date, accurate and The protection of personal data in the UK is primarily secure, and that data is processed fairly and governed by: lawfully; and (ii) observing restrictions on transferring personal data outside the European the Data Protection Act 1998 (DPA); Economic Area . the Freedom of Information Act 2000 (FOIA); and In practice, every company or other organisation in the Privacy and Electronic Communications (EC the UK is likely to be a data controller and will Directive) Regulations 2003 (Privacy Regulations) therefore need to comply with the Data Protection (ePrivacy Regulations) . Principles . The Information Commissioner has the power to fine a data controller up to £500,000 for However, alongside this legislation, there sits another serious breaches of the DPA . developing body of law regulating privacy in general, including: There are additional restrictions on the processing of the Human Rights Act 1998 (HRA), in particular sensitive personal data (such as data relating to racial the right to respect for private and family life or ethnic origin, religious beliefs, health, political (Article 8 of the European Convention on Human opinions and criminal records) . Rights, as enacted by the HRA); and 84 PRIVACY AND DATA PROTECTION HERBERT SMITH FREEHILLS

PRIVACY AND DATA PROTECTION

The DPA also grants a broad set of rights to and a national UK level . There is currently a individuals who are the subject of personal data, the fragmented patchwork of legislation governing this so-called data subjects . Within 40 days of a request area in the UK, of which data protection and privacy from a data subject, the data controller must identify laws form part . At the European level, the European and provide a copy of the personal data it holds Commission published a Cyber Security Strategy and relating to that individual and must explain the draft Directive in February 2013 setting out purposes of processing the data and to whom the measures to establish a unified approach to network data may be disclosed . The data controller can and information security across Member States . The charge the data subject up to just £10 to deal with draft Directive is listed as a priority item to be the request . Limited exemptions from this so-called adopted by the legislator in the Commission’s annual subject access right apply . work programme for 2014 and, once adopted, Member States are likely to have 18 months to bring Data subjects also have the right, among other the requirements into force . In the meantime, at the things, to: national UK level, the Government is working with stakeholders to encourage industry-led standards prevent use of their personal data for and guidance that can be used by organisations to marketing purposes; manage the risk to their information . have inaccurate data rectified or destroyed; and DATA PROTECTION REFORM sue a data controller for compensation for damage caused by its breach of the DPA . In January 2012, the European Commission published its legislative proposals for reform of the 1995 Data The ePrivacy Regulations govern the use of personal Protection Directive . The draft legislation represents a data in commercial communications by electronic significant reform and development of data protection mail, which includes fax, telephone and e-mail . They law in Europe and, in the UK, would replace the DPA . also regulate the use of location data and govern the Since the draft Regulation was published, there have use of cookies . been various revisions and recommendations . The draft has received approval from the European The FOIA gives the public the right of access to Parliament and is awaiting further approval from the information held by public authorities (including Council of the European Union . Once the Council’s personal data of individuals other than the applicant) position is clear, negotiations will then commence subject to any applicable exemptions and sets out between European Parliament and the Council . Key the procedure to be followed . highlights of the legislative proposal include: Structure: The proposed new legislation takes the INFORMATION SECURITY form of a Regulation rather than a Directive, Information security is important for many meaning that it would be directly applicable in the companies but perhaps particularly so for those with UK without requiring any implementing measures . increased cyber vulnerabilities . For example, Jurisdiction: The new law will be extended to apply companies storing large amounts of sensitive data to organisations even if they are located outside online, or those dependent on a substantial (often the EU, if they offer goods or services to EU retail) online presence . The issue of cyber security is residents, or monitor their behaviour . also high on the political agenda at both a European HERBERT SMITH FREEHILLS PRIVACY AND DATA PROTECTION 85

Data security breaches: The new law will require all data controllers to notify their data protection authority without undue delay of any personal data breach . Data processors: For the first time, data processors will also be directly subject to regulation under the new law . Some obligations, particularly in relation to data security, will apply directly to data processors . Consent: Under the new law, consent from data subjects will need to be explicit and obtained either by way of a statement or other clear affirmative action . Sanctions: Data protection regulators will be able to impose sanctions ranging from a written warning (in case of first and non-intentional failures) to fines of up to €100 million or 5% of annual worldwide turnover .

Whether all the proposals find their way into the final Regulation remains to be seen . However, the changes are likely to affect (to a greater or lesser extent) every single organisation doing business in the UK . As the draft Regulation envisages a two year period for organisations to plan for implementation, it is unlikely to be in force in the UK before 2016 at the very earliest, with some commentators suggesting it will not be before 2020 . 86 PRODUCT SAFETY AND LIABILITY HERBERT SMITH FREEHILLS

18. PRODUCT SAFETY AND LIABILITY

In recent years increased protection of products covered by the Regulations is wide and product is defined to include items which are sold or for consumers has brought about freely provided to consumers, as well as those goods significant developments in the law which are not intended for consumers but likely to be and it is important that businesses used by them . The Regulations contain a general obligation (referred to as the general safety (and investors) have an requirement) which prohibits producers or understanding of their legal distributors from placing or supplying a product on the market, or exposing or possessing a product for exposures to product safety and placing on the market which is unsafe . liability claims are not restricted to a particular legal system as Producers and distributors who contravene the general safety requirement can be served with a manufacturers and distributors are, notice by an enforcement authority . This notice can sometimes unwittingly, exposed to require them to suspend or halt the offending action, claims in different legal jurisdictions . to withdraw or recall the product in question, label the product or otherwise warn consumers who are at risk of the dangers posed by it . Contravention can The main product safety legislation in the UK is the also lead to criminal liability in the form of a custodial General Products Safety Regulations 2005 sentence and/or a fine . (SI 2005/1803) (the Regulations) . The Regulations apply to producers (ie, manufacturers) and PRODUCT LIABILITY distributors who may be exposed to sanctions if they place an unsafe product on the market . Contract A contract for sale or supply of a product may give Where the product causes injury, loss or damage to rise to liability in a number of ways: third parties the manufacturer or distributor of products may also be exposed to liability under Express terms English law, namely: (1) liability for breach of contract The contract may include express terms (orally or where liability is based upon the terms of any in writing) as to the nature or character of a relevant contract of sale or supply; (2) liability for product . The express terms may promise various breach of a general duty of care where liability is remedies, for example the right to repair, a based upon fault (tort); and (3) statutory liability replacement or refund . In addition, promises as to pursuant to the Consumer Protection Act 1987 (the the products and/or the remedies available may 1987 Act) which imposes a strict liability regime appear in a guarantee or extended warranty upon parties involved in the production and contract between the buyer and the seller/ distribution chain . distributor or manufacturer . These can exist alongside the main contract of sale/supply . PRODUCT SAFETY The Regulations entered into force on 1 October Implied terms 2005 . They implement the EC General Product Terms are implied into contracts for the sale of Safety Directive (2001/95/EC) and complement the products by statute . The Sale of Goods Act 1979 existing product specific regulations applying where (as amended) and the Supply of Goods and there is a gap in the regulatory framework . The range HERBERT SMITH FREEHILLS PRODUCT SAFETY AND LIABILITY 87

Services Act 1982 (as amended) imply terms as to breached which deprives the buyer of substantially the description, quality and fitness for a particular the whole benefit of the contract), he will have the purpose of products and arise in all contracts of right to reject the goods and terminate the contract . sale/supply . The implied term that products will With a contract of sale, the buyer may waive this correspond with their description applies to all right should he accept the goods . Acceptance in this contracts of sale/supply regardless of the status of sense occurs when the buyer intimates to the seller, the parties involved whereas the implied terms either expressly or impliedly, that he has accepted that products are of satisfactory quality (ie, they the goods, or does any act inconsistent with the meet the standard that a reasonable person would ownership of the seller . regard as satisfactory) and are fit for any purpose made known to the seller apply only to those who Exclusion and limitation of liability sell/distribute in the course of business . The The rights and remedies provided by the implied terms impose strict liability in that the contract-based regime are also affected by various buyer does not need to establish fault on the part rules on the exclusion and limitation of liability, the of the seller, merely that, the products were most important of which are contained in the ill-fitting with their description, of unsatisfactory Unfair Contract Terms Act 1977 (UCTA) and the quality or otherwise unfit for their purpose . Unfair Terms in Consumer Contracts Regulations 1999 . UCTA creates a test of reasonableness Pre-contractual statements which must be satisfied by any clause in a contract A statement made prior to the conclusion of the for sale or supply which purports to exclude or contract of sale/supply which relates to the limit liability for breach of express terms . Liability characteristics, qualities or some other feature of cannot, under any circumstances, be excluded or the product can give rise to a number of legal limited in respect of a breach of an implied term consequences which may expose the maker of the where the buyer of the goods or services is statement to liability regarding the product . In the a consumer . law of contract, such statements may be incorporated as a term of the main contract of sale/ Tort supply, or form the basis of a separate contract The general principle between the buyer and the seller/distributor or between the buyer and a third party which is The liability of a product manufacturer under the collateral to the main contract of sale/supply . English law of tort is fault-based . Indeed it was in the landmark decision of Donoghue v Stevenson Compensation may be available following any [1932] AC 562, in which Mrs Donoghue breach of contract as follows: discovered a decomposing snail in her bottle of ginger beer, that the House of Lords first Damages articulated the general principle that a manufacturer of products which are sold in such a For any breach of contract, the buyer will be able to form as to show that he intends them to reach the claim damages (intended to put the buyer in the ultimate consumer in the form in which they left position in which he would have been had the him with no reasonable possibility of intermediate contract been properly performed) . In certain examination, and with the knowledge that the situations (where any of the implied terms described absence of reasonable care in the preparation of above have been breached, where the contract the products will result in an injury to the consumer expressly provides or where a term has been 88 PRODUCT SAFETY AND LIABILITY HERBERT SMITH FREEHILLS

PRODUCT SAFETY AND LIABILITY

or his property, owes a duty to the consumer to Compensation/damages take reasonable care . That general principle For any breach of duty of care in tort, the buyer will underpins the basis of the modern English law be able to claim damages (intended to put the of negligence . buyer back in the position in which he would have been in before the tort was committed ie, as if Test for liability in the tort of negligence there has been no breach of the duty of care) . As liability in negligence is based on fault, the injured party has the burden of proving: ACTIONS IN CONTRACT VERSUS ACTIONS IN TORT that the manufacturer owed him a duty of care; There are a number of advantages for the injured that the duty was breached (ie, that the party should he pursue a claim in contract . In manufacturer was at fault because his conduct contrast to a negligence claim, there is no need to fell below the required standard of care); and establish a duty of care or a breach of this duty . In that the breach caused the damage suffered and most cases there is strict liability . The buyer can that the damage was, or ought to have been, recover loss caused by the product simply not being foreseeable at the time of the breach . worth what it would have been had it conformed to the contract and the defences open to the Duty of care manufacturer under The Consumer Protection Act 1987 (the 1987 Act) (discussed below) are not The principle established in Donoghue imposes a available in a claim in contract . However, in many duty of care on manufacturers of defective cases the immediate supplier to the consumer may products, which includes anyone directly involved not have the wherewithal to pay a claim in which in the manufacture of the product (held in event the contractual claim will be of little value . subsequent cases to include assemblers, repairers Before the coming into force of the 1987 Act, the only and inspectors) . The neighbour principle alternative was to claim against someone further up formulated in this case established that the the contractual chain, usually the manufacturer, manufacturer owed a duty of care to those persons alleging breach of a duty of care (ie, tort) . who are so closely and directly affected by the manufacturer’s acts that he ought reasonably to CONSUMER PROTECTION ACT 1987 have them in contemplation as being so affected Since 1987 the UK, in common with all EU Member when carrying out his business . States, has imposed a strict liability regime on parties in the production and distribution chain in respect of Standard of care claims by consumers who have suffered damage as a The standard of care expected of a manufacturer is result of a defective product . The 1987 Act transposed tested objectively . A manufacturer will be negligent the Product Liability Directive (85/374/EEC and if he has failed to act as a reasonable person 1999/34/EC) into UK law . The 1987 Act only applies (possessing the same skills) would have acted . If a to products supplied after 1 March 1988 . particular danger could not reasonably have been anticipated then the manufacturer will not be at Strict liability regime fault . Section 2(1) of the 1987 Act imposes liability where any damage is caused wholly or partly by a HERBERT SMITH FREEHILLS PRODUCT SAFETY AND LIABILITY 89

defect in a product . This is strict liability in that the determining such expectations . These include the defect need not have resulted from another party’s way in which the product has been marketed, any negligence, provided that it can be demonstrated instructions for the use of the product, any that the product was defective and the defect in warnings provided, to what use the product may the product caused the damage . A person can sue reasonably be expected to be put and the time the for death, personal injury or damage to property . product was supplied .

Test for liability Defences Liability under the 1987 Act only exists where Section 4 of the 1987 Act lists six specific defences something within the 1987 Act’s definition of a to the strict liability imposed by the 1987 Act . product contains a defect which causes damage . These defences exist where: the defect is Section 1(2) defines product as any goods or attributable to compliance with any mandatory electricity used and includes a product which is rules imposed within the EU; the person proceeded comprised in another product, whether by virtue of against did not at any time supply the product to being a component part or raw material or otherwise . another; the supply of the defective product was Goods are given a wide definition under the 1987 Act . between two persons not engaged in a course of The legislation only applies to consumer products business; the defect did not exist in the product at and products used at a place of work . the relevant time; the state of scientific and technological knowledge at the relevant time was Who is liable not such that the producer of the product might have been expected to discover the defect; and the The 1987 Act selects, on policy grounds, those defect arose because of the way a component part links in the production and distribution chain that was used in the final product . The burden (on the should be liable . By section 2(2) liability is imposed balance of probabilities) of establishing any of upon the producer (which includes, most simply, these defences rests upon the defendant . the manufacturer), importer into the EU (which gives consumers the advantage of having a target 1987 Act versus actions in tort of negligence defendant within the EU) and own-branders (which includes any entity which puts its name, An action in negligence can still prove to be an trade mark or other distinguishing feature to a important route for an injured party despite the product and, as a result, holds itself out as being advent of the 1987 Act . It may be in the injured the producer) . Liability is also imposed upon party’s interests to bring a negligence action in suppliers, although there exists a defence should addition to an action under the 1987 Act, since the supplier reveal to the consumer the identity of the 1987 Act contains specific defences that are the producer or importer . not available to the manufacturer/producer in negligence . Defect

There must be a defect in the product if there is to be liability under the 1987 Act . Defect is defined by section 3(1) as existing when the safety of the product is not such as persons generally are entitled to expect and the 1987 Act includes a list of circumstances to be taken into account in 90 MONEY LAUNDERING HERBERT SMITH FREEHILLS

19. MONEY LAUNDERING

The UK anti-money laundering property derived from any criminal conduct, anywhere in the world, no matter how minor . The regime creates broad-ranging money offences are: laundering offences and, additionally, concealing, disguising, or converting criminal imposes systems and controls in property, or removing it from the jurisdiction; various sectors with a view to entering into or being involved in an arrangement deterring criminal activity . Its impact which facilitates the acquisition, retention, use or can be unexpectedly wide and needs control of criminal property; and to be considered carefully . acquiring, using or possessing criminal property . In each case, knowledge or suspicion that the THE ANTI-MONEY LAUNDERING property is of criminal origin is required . REGIME Given the broad definition of “criminal conduct”, The UK’s anti-money laundering regime is designed the broad scope of “laundering” activity, and the to assist the UK authorities to detect, disrupt and low threshold of “suspicion”, the money laundering deter money laundering, and the criminal activity legislation can be triggered surprisingly easily . A which underlies it . It can be divided into three defence to these offences is, however, available, if a elements: (a) the substantive law, which criminalises person reports their suspicions and obtains involvement in money laundering and in certain consent from the National Crime Agency (NCA) circumstances imposes obligations to report to any acts which would otherwise constitute suspected money laundering – which applies to all money laundering . persons in the UK, (b) the administrative/compliance requirements, which require firms to have systems Separately, businesses in the Regulated Sector are and controls to forestall money laundering – which obliged to make a report to the NCA where they apply to certain sectors, including the financial know, suspect or have reasonable grounds to sector, certain types of professional services firms, suspect that another person is engaged in money and some other businesses (the “Regulated Sector”); laundering, and that knowledge or suspicion is and (c) additional regulatory requirements which are based on information which has come to them in imposed by the Financial Conduct Authority (FCA) the course of their regulated business . This on authorised firms in the financial sector . obligation can require reports to be made about third parties, clients, customers, counterparties, A similar regime (of substantive offences and and any others involved in money laundering . It is a sector-based compliance requirements) applies in criminal offence to fail to report . relation to the prevention of terrorist financing . In practice, firms in the Regulated Sector appoint a “nominated officer” within the business, who SUBSTANTIVE LAW receives reports from employees and decides Proceeds of Crime Act 2002 (POCA) whether to make a report to the NCA . The NCA receives and analyses suspicious activity reports, There are three principal money laundering records them on its database, and may initiate offences created by POCA, which apply to anyone investigations, either by taking action itself or, (whether in or outside the Regulated Sector) who more commonly, by passing the reports to other may be involved in possessing or dealing with any HERBERT SMITH FREEHILLS MONEY LAUNDERING 91

law enforcement agencies . Certain public basis, his or her identity should be verified . authorities and law enforcement agencies also Information must also be obtained on the have direct access to the database of reports . purpose and intended nature of the business relationship . In certain circumstances, It is an offence for those in the Regulated Sector to “enhanced due diligence” must be undertaken . tip off a suspected money launderer or for those In practice, this is one of the most onerous outside the Regulated Sector to take action which compliance requirements imposed by they suspect would prejudice an investigation . the Regulations; The penalties for committing an offence under ongoing monitoring of customer relationships . POCA range from a maximum of between five and This entails implementing a method of reviewing 14 years imprisonment and/or an unlimited fine . transactions to identify those which are out of ADMINISTRATIVE REQUIREMENTS line with the customer’s expected activity (or which are otherwise suspicious), and additionally Money Laundering Regulations 2007 keeping the documents, data or information (the Regulations) obtained for the purpose of applying customer The Regulations require persons within the due diligence measures up-to-date; Regulated Sector to establish and maintain record-keeping procedures (relating to all appropriate and risk sensitive policies relating to customer identification obtained and relevant the prevention of money laundering . These records relating to the business relationship or include, for example: transaction); and training for employees on the laws relating to the appointment of a nominated officer and money laundering and terrorist financing; and implementation of internal reporting procedures . how to recognise and deal with transactions and other activities which may be related to money The Regulations set out what types of businesses laundering or terrorist financing; and services are subject to these requirements . They include (but are not limited to) almost every policies and procedures relating to internal kind of banking and financial services business, control, risk assessment, and the management money services businesses, external accountants, and monitoring of money laundering and auditors and tax advisers, lawyers in certain terrorist financing risk . A risk assessment of the circumstances, trust and company services business must be conducted to determine what providers, casino operators, estate agents and risks it faces from money laundering and dealers in high value goods . A service line can be terrorist financing (in light of its customer base, subject to the Regulations even if it is not the firm’s products, services and other relevant matters) principal activity . and what policies and procedures are needed to address those risks; Contravention of the Regulations is an offence punishable on conviction up to a maximum of two customer due diligence . This requires a business years’ imprisonment and/or a fine . to identify its customers, and verify their identity using documents, data or information from a reliable and independent source . Where the customer has a “beneficial owner”, the beneficial owner must be identified and, on a risk sensitive 92 MONEY LAUNDERING HERBERT SMITH FREEHILLS

MONEY LAUNDERING

REGULATORY REQUIREMENTS practicable if they obtain information in the course of Financial Conduct Authority (FCA) their trade, profession, business or employment, which causes them to believe or suspect that another For those it regulates, the FCA polices compliance person is engaged in terrorist money laundering . with the Regulations and has the power to levy fines for non-compliance . There is a separate reporting requirement, imposed on all persons (in whatever capacity they receive the The FCA also imposes separate requirements on information), to report certain information that regulated firms, obliging them to have systems and might prevent acts of terrorism or assist in the controls to address the risk that they may be used apprehension or prosecution of terrorists . for financial crime – including requirements to adopt certain anti-money laundering systems and The penalty for not making a disclosure is up to controls . The requirements are relatively high level five years imprisonment and/or an unlimited fine . and overlap to a significant extent with the Sanctions/asset freezes requirements of the Regulations . They are set out in the SYSC (Systems and Controls) section of the Certain individuals and entities (known as FCA’s Handbook, and supplemented by additional “Designated Persons”) are subject to asset freezes . guidance in the FCA’s handbook guide “Financial There is a prohibition on dealing in such persons’ Crime: a Guide for Firms” . assets, on making funds or economic resources available to them without a licence and, in some Whilst the FCA’s requirements are less detailed than cases, on making financial services available to those of the Regulations, in practice FCA regulated them . Some sanctions of this sort are adopted to firms face greater enforcement risk in relation to implement EU restrictive measures, but the UK systems and controls failures than other parts of the also operates a domestic sanctions regime in Regulated Sector, and will need to have careful regard relation to terrorist suspects . to the FCA’s expectations and guidance . Designated Persons may be listed under a number Other regulators are responsible for supervising of different statutes and statutory instruments, other parts of the Regulated Sectors’ compliance and the relevant enabling legislation will set out the with the Regulations and may impose additional specific restrictions which apply in each case . A list regulatory obligations . (the “consolidated list”) of all Designated Persons Terrorism Act 2000 is published by HM Treasury . The Terrorism Act 2002 creates criminal offences Given that some Designated Persons are listed relating to terrorist financing and terrorist fund because of their involvement in terrorism, and raising, as well as laundering the proceeds of because the Regulations require firms to have terrorist activity . It also imposes reporting systems and controls to counter the risk of terrorist obligation, and creates tipping off offences . financing, firms which are part of the Regulated Sector will need to have systems and controls to Those within the Regulated Sector must make a address compliance with financial sanctions report if they know or suspect, or have reasonable regimes . Non-regulated firms may also wish to grounds for knowing or suspecting, that a terrorist have such systems and controls in place to finance offence has been committed . minimise the risk of committing an offence of dealing with a Designated Person . Additionally, persons outside the Regulated Sector must make a report as soon as is reasonably HERBERT SMITH FREEHILLS Litigation 93

20. Litigation

On acquiring a business or company actions in contract and tort . There are also a number of specialist courts, including the Commercial Court . in the UK, there may be continuing litigation involving that business or The Court of Appeal (Civil Division) hears appeals company which will need to be from the County Court and the High Court . The Supreme Court hears appeals from the Court of considered at the time of acquisition . Appeal (and sometimes directly from the High Similarly during the course of running Court) . The Supreme Court took over the judicial a business, litigation may occur from function of the House of Lords on 1 October 2009 . time to time and prove to be a costly The Judicial Committee of the Privy Council is the and time-consuming matter . final court of appeal for a number of Commonwealth countries . COURT SYSTEM There are also specialist Tribunals such as the The structure of the civil court system First-Tier Tax and Upper Tribunals . Appeals from the Civil proceedings in England and Wales are Upper Tribunal are made to the courts . conducted in the County Court or in the High Court . JUDGES AND JURIES From 22 April 2014 the previous structure of some The role of the judge and, where 170 separate county courts, each exercising its applicable, the jury in civil proceedings powers for a limited geographical area, has been Civil cases are, generally, heard at first instance by a replaced by a single County Court, operating as a single judge . Exceptions include claims in respect of single national entity for England and Wales . If the malicious prosecution or false imprisonment, where value of a claim is below a certain threshold there is a presumption in favour of trial by jury . As a (£100,000), the claim must be started in the County result of the Defamation Act 2013, there is no longer Court . If the value of the claim exceeds this threshold such a presumption in defamation cases (ie, libel and it can be started in the County Court or in the High slander) so that cases are tried by a judge alone Court . However, usually the High Court hears high unless the interests of justice require a jury trial . value claims . While the introduction of the Civil Procedure Rules The High Court has three divisions: (CPR) in 1999 has to some extent altered the role of The Queen’s Bench Division; the judge in civil proceedings – encouraging the court to take a more interventionist case management role The Chancery Division; and – the civil justice system remains adversarial and the The Family Division . judge’s role during trial remains passive rather than inquisitorial . The Queen’s Bench Division deals with most types of claim in contract and in tort . The Chancery Division Limitation issues – the time limits for deals with cases involving land, mortgages, bringing civil claims execution of trusts, administration of estates, Most limitation periods are laid down by the bankruptcy, partnerships and deeds, as well as Limitation Act 1980 . The basic rule for actions based 94 Litigation HERBERT SMITH FREEHILLS

Litigation

on contract or tort is that the claimant has six years Starting proceedings from the date of the cause of action to commence Proceedings are commenced by the issue of a claim proceedings . In contract, time runs from the breach form which is lodged with the court and served on of contract . In tort, unless the tort is actionable the other parties . without proof of damage, the cause of action accrues when damage occurs . The claim form provides details of the amount that the claimant expects to recover, full details of the The limitation period for a claim in respect of a parties and details of the claim (which may be set out document entered into as a deed is 12 years either in the claim form itself or in a separate from breach . document called the particulars of claim) . A claim form must be verified by a statement of truth which In cases of fraud, deliberate concealment or mistake, is a statement that the party presenting the the limitation period does not run until the claimant document believes that the facts stated in it are true . has discovered the fraud, concealment or mistake or A fee is payable, based on the value of the claim . could with reasonable diligence have discovered it . Timetable THE LIFE OF A CASE Pre-action behaviour If the defendant wishes to dispute the claim, he must serve a defence . The timetable for service of a Pre-action protocols outline the steps that parties defence is capable of being extended by agreement should take to seek information from and to provide between the parties (for up to 28 days) or by information to each other about a prospective legal application to the court . In most cases, the defendant claim . Their purpose is to encourage the exchange of has at least 28 days from service of the particulars of early and full information about the prospective legal claim to serve his defence . claim, to enable parties to avoid litigation by agreeing a settlement of the claim before the commencement A case management conference (CMC) generally of proceedings and to support the efficient follows where the court makes directions as to the management of proceedings where litigation cannot steps to be taken up to trial, including the exchange be avoided . of evidence (documentary disclosure, witness statements and expert reports) . The court will fix the In addition, under the CPR, a party may apply to the trial date or the period in which the trial is to take court for disclosure of documents before place as soon as is practicable . proceedings have started from a party who is likely to be a party to proceedings . Cases can come to trial as quickly as six months from issue . Often, however, they will take between one An extra weapon in the claimant’s armoury is the and two years, and sometimes longer . Norwich Pharmacal order . Such an order can be sought where the claimant has a cause of action but Case management (control of the case) does not know the identity of the persons who Under the CPR, case management has effectively should be named as defendants . The court may shifted from the parties to the judge, who enjoys order a third party who has been involved in the considerable powers, including control over the wrongdoing, even if innocently, to disclose the issues on which evidence is permitted and the way in identity of the defendant(s) or provide information to which evidence is to be put before the court . assist the claimant in bringing the claim . HERBERT SMITH FREEHILLS Litigation 95

Nevertheless, there is some scope for the parties to Interim remedies vary by agreement the directions made by the court, The court has wide powers to grant parties to an provided that the variation does not affect any key action various interim remedies (remedies available dates (eg, the date of the pre-trial review or the trial during the course of proceedings before the trial or itself) . As a result of rule changes introduced in April final outcome) including interim injunctions, freezing 2013, the courts have taken an increasingly strict injunctions, search orders, specific disclosure and approach to enforcing compliance with court rules payments into court . and orders .

Documentary evidence/privilege Usually English courts will only make orders relating to property within the jurisdiction . However, in Disclosure of documents will usually be ordered by exceptional circumstances, the English court will the court when making directions at the CMC . make a worldwide freezing injunction . Also, English courts may grant interim relief (typically freezing A document is subject to legal professional privilege injunctions) in aid of legal proceedings anywhere in (and does not need to be shown to the other parties) the world . if it falls into one of two principal categories: Remedies a) Legal advice privilege: communications between client and lawyer for the purpose of giving or Common remedies awarded by the courts are receiving legal advice . damages (aimed at compensating the claimant rather than punishing the defendant), declarations, b) Litigation privilege: communications between injunctions (mandatory or prohibitory), specific client and lawyer or between either of them and performance (a form of mandatory injunction) or a third party for the dominant purpose of giving orders for the sale, mortgaging, exchange or or receiving advice in relation to litigation or partition of land . Interest may be payable on collecting evidence for use in litigation . The money judgments . litigation must be pending or in reasonable contemplation . Enforcement Witness statements and expert reports The following are the principal means of enforcement: At the CMC, the court will ordinarily also make writs of control in the High Court or warrants of directions for exchange of written statements of control in the County Court, whereby the relevant factual and expert witnesses on whose evidence the enforcement agent has authority to take control of parties wish to rely . Under the CPR, parties are and sell the debtor’s property; encouraged to use a single joint expert in appropriate third-party debt orders (or garnishee proceedings) cases . Evidence for pre-trial hearings is almost which operate to stop funds reaching the debtor always provided in writing . However, factual and from a third party (such as a bank) by redirecting expert witnesses will generally be called to give oral them instead to the creditor; evidence at trial . charging orders over land or securities; and 96 Litigation HERBERT SMITH FREEHILLS

Litigation

if a company is unable to pay its debts, insolvency proceeds of the claim if successful . If the claim fails, proceedings . Insolvency proceedings can include the third party may be liable for some or all of the petitioning the court for the appointment of a successful defendant’s legal costs . The case law is liquidator, whose principal duty will be to realise still developing, but the approach of the English the assets of the company and distribute them to courts has been to uphold such arrangements those entitled . provided that they are not otherwise contrary to public policy . Costs The court has discretion whether to order that costs Insurance is also available for litigation costs . There are payable by one party to the other, the amount of are two types: the costs, and when they are to be paid . However, Before the event (BTE) policies: legal expenses usually in litigation, the winning party will recover insurance policies which are typically taken out some or most of its costs from the losing party . with an annual premium .

Fee arrangements After the event (ATE) policies: such policies typically cover a party’s disbursements (eg, English lawyers generally bill based on hourly rates in counsel and expert fees) and the risk of paying an commercial litigation . opponent’s legal fees if the insured is unsuccessful in the litigation . They may also cover the insured’s English law permits conditional fee agreements in own legal expenses, although this is less common . relation to civil litigation matters whereby the solicitor receives a lower payment or no payment if APPEALS the case is lost, but generally higher than normal payment if the client is successful . However, for An unsuccessful party may appeal from the County conditional fee agreements to be enforceable, certain Court or the High Court to the Court of Appeal, and formalities must be followed including that the uplift from the Court of Appeal to the Supreme Court . on success cannot exceed 100% of the normal rate . Conditional fee agreements are still relatively Permission to appeal is generally required . For uncommon in larger commercial cases . permission to appeal to the Court of Appeal, the appeal must have a real prospect of success or there Contingency fee agreements (that is, fees based on must be some other compelling reason for the a percentage of the proceeds of the case) have appeal to be heard . For an appeal to the Supreme been permitted since April 2013 as a result of Part II Court, there must be an arguable point of law of of the Legal Aid, Sentencing and Punishment of general public importance . Offenders Act 2012 which implements recommendations put forward by a senior judge, The appeal court will not allow an appeal unless it Lord Justice Jackson, following a year-long review of considers that the decision of the lower court was civil litigation costs . wrong or it was unjust because of a serious procedural or other irregularity in the proceedings . Third party funding is where a third party funds litigation, normally in return for a share of the HERBERT SMITH FREEHILLS Litigation 97

FOREIGN JUDGMENTS The procedure for enforcing a foreign judgment in England depends on the arrangements which have been made with the foreign country in question . Where there are no arrangements in place (such as in relation to the United States and China), enforcement of judgments of the courts of these countries is covered by common law . In these circumstances the party seeking enforcement must bring an action on the judgment . 98 ARBITRATION HERBERT SMITH FREEHILLS

21. ARBITRATION

Arbitration is an important CHOICE OF ARBITRATOR alternative to litigation in the If there is no agreement as to the number of arbitrators, the tribunal shall by default consist of a English courts . sole arbitrator . ARBITRATION – AN EXPLANATION The parties are free to agree on the procedure for UNCITRAL Model Law appointing the tribunal . In the absence of such The Arbitration Act 1996 reflects in many respects agreement, one party may serve a written request on the provisions of the UNCITRAL Model Law . the other to make a joint appointment (if the tribunal is to consist of a sole arbitrator) or requesting that There is no longer any major distinction between each party appoint one arbitrator (if the tribunal is to domestic and international arbitration . consist of three arbitrators, with the two so chosen appointing the chairman) . In the event of a failure of Arbitration agreements – an appointment procedure, the parties may apply to formal requirements court to exercise its powers to complete the appointment procedure . Under the Arbitration Act 1996, consistent with the 1958 New York Convention on the Recognition and A party may challenge an arbitrator by an application Enforcement of Foreign Arbitral Awards (the to court for his/her removal if: there are justifiable New York Convention), there must be an agreement grounds as to his/her impartiality; if he/she does not in writing to submit present or future disputes have the necessary qualifications; is physically or (whether contractual or not) to arbitration . The term mentally incapable; or has failed properly to conduct agreement in writing has a very wide meaning: for the proceedings; and substantial injustice has or will example the agreement can be found in an exchange thereby be caused to the party . Pending the outcome of communications . of such an application, the tribunal can proceed with the arbitration and make an award . Courts in England will stay litigation proceedings in favour of arbitration if there is prima facie, evidence of PROCEDURE an arbitration agreement between the parties . Moreover, courts may grant an injunction to prevent As party autonomy is the overriding objective of the parties from pursuing litigation proceedings in law, it is up to the parties to select the rules of foreign courts in breach of an arbitration agreement procedure that will govern the arbitration . However, if (although this power is no longer available in respect no express provision is made in the arbitration of proceedings in the courts of the European Union agreement, it is for the tribunal to decide procedural following the decision of the European Court of and evidential matters . Justice in the West Tankers case) . The tribunal is at all times bound by the mandatory Oral arbitration agreements are recognised by provisions of due process and to act fairly and English law but fall outside the scope of the impartially between the parties . Arbitration Act 1996 and the New York Convention . HERBERT SMITH FREEHILLS ARBITRATION 99

CONFIDENTIALITY As to the form of award, if this is not agreed between the parties, it should be in writing, signed by all the Parties are free to include express provisions in their arbitrators, contain reasons and state the seat of the contracts relating to confidentiality in arbitral arbitration and the date it is made . proceedings . In the absence of express agreement, the English courts will imply a duty of confidentiality APPEALS and require the parties to an arbitration and the tribunal to maintain the confidentiality of the hearing, There are limited grounds for an appeal of an award the documents generated and disclosed during the to the courts . arbitral process and the award itself . Confidentiality can be waived by the court in certain limited A party may challenge an award on the grounds of circumstances . the tribunal’s lack of jurisdiction or because of a serious irregularity in the proceedings that has COURT INTERVENTION caused substantial injustice to the aggrieved party . This test is quite onerous and an award will only be The courts’ role is strictly supportive and their set aside in rare cases . Neither of these mandatory intervention in the arbitral process is limited . provisions may be excluded by agreement between the parties . However, the courts may provide assistance in certain procedural matters and have powers to order In limited circumstances, a party may also challenge interim measures in certain circumstances . Many of an award on a point of law . Only appeals on English the courts’ powers can be excluded by the parties law are permitted . An appeal on a point of law by agreement . requires the agreement of all the other parties to the INTERIM RELIEF proceedings or the leave of the court . Parties may exclude the right to appeal on this ground by Parties are free to agree the powers exercisable by agreement . An agreement that the arbitrator need the tribunal . Absent agreement to the contrary, the not give reasons for his decision is treated as an tribunal has authority to make orders for security for agreement to exclude this right of appeal . costs and the preservation of property and evidence . The tribunal can, for example, grant a freezing There is no right to appeal to the courts on a question injunction or an interim mandatory injunction . of fact .

Parties may agree that the tribunal has power to ENFORCEMENT order on a provisional basis any relief which it would The winning party to an award made in England may have power to grant in a final award eg, payment of apply to the courts for permission to enforce the money or disposal of property . Such provisional relief award as if it were a court judgment . will be subject to the final award of the tribunal .

AWARD Awards made in a contracting state to the New York Convention (such as an award made in China) will be The tribunal may make its award at any time, unless recognised and enforced in England and Wales, otherwise agreed by the parties in writing . The subject to limited exceptions set out in the tribunal must, however, produce its award promptly Arbitration Act 1996 . Awards made in other after the conclusion of the hearing . countries may also be recognised and enforced in England and Wales . 100 ARBITRATION HERBERT SMITH FREEHILLS

ARBITRATION

COSTS Unless agreed to the contrary, the tribunal can order one party to pay the costs of the arbitration . The general principle is that the loser pays the costs, which include the tribunal’s fees . However, this is at the discretion of the tribunal who will take into account all the circumstances of the case, including the conduct of the parties during the arbitration . Any pre-agreement that one party should pay the costs of an arbitration is only valid if made after the dispute has arisen . HERBERT SMITH FREEHILLS ALTERNATIVE DISPUTE RESOLUTION 101

22. ALTERNATIVE DISPUTE RESOLUTION

Alternative dispute resolution (ADR) ii . failed to respond to a request to mediate (even if there might have been reasonable grounds to is a term used to describe a range of expressly decline to mediate) . processes outside traditional litigation or arbitration which can be In arbitration, a tribunal would require nothing more than evidence that the parties had complied with any used to resolve disputes quickly, contractual agreement to negotiate or mediate confidentially and economically . In before referring a dispute to arbitration (such recent years the courts have strongly multi-tiered clauses being common) . encouraged the parties to litigation THE TYPES OF ADR PROCESS to attempt to resolve their disputes COMMONLY USED through ADR before reverting to the Mediation: This is by far the most common courts themselves . This trend has method and is a consensual and confidential process in which a neutral third party, who has no continued to intensify with the recent decision-making power, helps the parties to reach reforms aimed at reducing costs in a negotiated agreement, usually through a process the civil justice system . of shuttle diplomacy . One of the principal advantages of mediation over direct negotiations is THE REQUIREMENT TO CONSIDER that parties are able to assess with the mediator ALTERNATIVE DISPUTE privately and in confidence the strengths and RESOLUTION (ADR) weaknesses of their respective positions in a way that would be difficult or impossible in a face to English courts will not force a party to engage in ADR face negotiation . if it is unwilling to do so . However, under the Civil Procedure Rules, the pre-action protocols and a Early neutral evaluation: This is where a neutral practice direction on pre-action conduct prescribe third party gives a preliminary, non-binding steps to be taken prior to the commencement of assessment of facts, evidence or legal merits . proceedings and these oblige prospective litigants to Expert determination: This is where a neutral consider the use of ADR . third party, acting as an expert rather than judge or Once proceedings are commenced, the court’s duty arbitrator, is appointed to decide the dispute with of active case management includes encouraging the no right of appeal . parties to use ADR if considered appropriate and Adjudication: This is where a neutral third party facilitating the use of ADR (sometimes through the (an adjudicator) is appointed to decide a dispute use of court orders providing for a stay of The adjudicator’s decision is binding unless or until proceedings while the parties attempt ADR) . The the dispute is finally determined through the courts courts may also penalise a party in costs if it has: or arbitration proceedings, or by agreement of the i . unreasonably refused to attempt ADR or parties . There is a statutory right to adjudicate unreasonably delayed in doing so . The burden of disputes that arise during the course of a proof is on the losing party (who will usually be construction project . Parties may also required to pay the winning party’s costs of the contractually elect to adjudicate disputes . litigation) to demonstrate that the winning party was unreasonable in its refusal; or 102 ACQUIRING AND INVESTING IN PROPERTY HERBERT SMITH FREEHILLS

23. AC QUIRING AND INVESTING IN PROPERTY There are three different and distinct It will be an estate held by a tenant under a lease . This will be carved out of a freehold or superior legal systems which operate in leasehold estate – see below . relation to real estate in the UK . This Commonhold is an alternative form of freehold commentary relates to property ownership introduced in 2002 . It provides for situated in England and Wales . ownership of an individual unit within a larger freehold development . To date commonhold has Separate legal systems apply to rarely been encountered . property situated in Scotland and Northern Ireland . LEASES A lease is a contract between a landlord and tenant ACQUISITION OF REAL ESTATE IN which grants the tenant a leasehold estate . The ENGLAND AND WALES BY length of the lease must be certain (ie, it must be FOREIGN INVESTORS either for a fixed term or be capable of being brought There are no restrictions on foreign nationals to an end by notice) . It is also vital that the tenant is acquiring property in England and Wales . Property given exclusive possession of the premises in can be purchased or rented/leased by individuals or question, otherwise he will not obtain a leasehold companies for their own use or as an investment, estate but merely a personal licence . This is subject only to the tax rules referred to below and in important because legislation confers certain very Chapter 13 above . There are a number of structures significant benefits to tenants, but not to licensees . which can be used to invest in property such as Currently there is no “standard” or prescribed form property companies, partnerships and joint venture of lease as lease provisions are freely negotiated in vehicles . Real estate investment trust (REIT) the market between the landlord and tenant at the structures are also available . time the new lease is granted . There are two main types of lease: TYPES OF PROPERTY INTERESTS AND OWNERSHIP The ground lease: this is a long lease granted in return for a capital sum paid, a “premium”, The Law of Property Act 1925 established that only together with a rent payable throughout the term two forms of legal estate in land can exist namely: of the lease . Long leases are typically granted for 99, 125 or even 999 years and the rent is usually A freehold estate . Although the Crown technically nominal, although in the commercial arena there owns all land, a freehold is thought of as absolute may be an element of gearing . Owning a ground ownership . A freehold estate is held in perpetuity lease is sometimes considered similar to owning a ie, it is not time-limited . A freehold estate can freehold, because a ground lease has a capital include the soil beneath the surface of the land and value and is capable of being used as security to the airspace above (although in practice this is raise funding . curtailed by planning and aviation law) . An investor may prefer to own a freehold as this gives total The rack rent lease: this type of lease is often used control over the property and enables the grant of for occupation of commercial or business leases of the property to secure an income stream . premises . Traditionally these leases were granted for periods of up to 25 years but recent market A leasehold estate . This is an interest for a term of research suggests that the average lease length is years absolute ie, the land is held for a limited time . now less than 10 years . Usually no premium is HERBERT SMITH FREEHILLS ACQUIRING AND INVESTING IN PROPERTY 103

payable but the tenant pays a full open market the tenant’s right to security of tenure . This is called rent, quarterly in advance . Typically the lease will “contracting out” and commonly occurs . To be require the rent to be reviewed to the market rent effective, a strict statutory procedure must every five years, with a proviso that the rent cannot be followed . decrease but can only stay the same or increase . Alternatively some leases permit fixed rent REGISTERED LAND v increases, or index-linked increases and some UNREGISTERED LAND permit the rent to be determined by reference Registered land to turnover . Approximately 80% of the land and property in An occupational lease will generally require the England and Wales is registered at the Land tenant to be responsible for the full costs of repair, Registry . Each real estate interest is allocated a maintenance, reinstatement and insurance of the separate register and a unique title number . The property, in addition to paying the rent . This is known register is open to the public and anyone can as a full repairing and insuring lease (FRI lease) . inspect and make copies of it or any document Additionally, the lease will usually require the tenant referred to in it . The register contains details of the to obtain the landlord’s consent before transferring type of estate (freehold or leasehold) and a brief the lease to a third party (by assigning or underletting description of the land by reference to a filed plan . the property) and before carrying out alterations to The register also gives the name and addresses of the property or changing its use . Where a property is the owner of the legal estate, details of any let to a number of different tenants the landlord will limitations on the owner’s ability to deal freely with retain responsibility in relation to the structure and the land and details of any charges affecting the the common parts of the building . However, he registered title . will recharge all his costs to the tenant via a service charge . In limited circumstances the Land Registry has discretion to restrict public access to certain SECURITY OF TENURE information contained in registered documents . A tenant of business premises is given security of There is a state guarantee of title for registered tenure by the Landlord and Tenant Act 1954 . This land . A statutory compensation scheme exists means that when the lease comes to an end, the which, in prescribed circumstances, pays tenant has a statutory right to be granted a new compensation to anyone who suffers loss as a lease, on similar terms to the previous lease but at a result of an error on the register . The registered market rent . The landlord can only oppose the grant land system recognises four different classes of of a new lease on a limited number of grounds title, the most common and best of which is which include the landlord wishing to occupy or title absolute . redevelop the property or the tenant having breached the terms of the lease, eg by failing to pay Unregistered land the rent or failing to repair the property . If the The remaining unregistered land is generally in landlord successfully resists the grant of a new rural areas . It is compulsory to register this land lease, (on grounds other than the tenant’s default) when a statutory trigger event occurs . These the tenant may be entitled to statutory include the transfer of a freehold, the grant of a compensation . Before entering into a business lease for more than seven years, the sale of a lease lease, the landlord and tenant can agree to exclude with more than seven years to run and the grant of 104 ACQUIRING AND INVESTING IN PROPERTY HERBERT SMITH FREEHILLS

ACQUIRING AND INVESTING IN PROPERTY

a mortgage . Ownership of land which has not yet Some transactions, such as the sale of a let been registered is evidenced by possession of the commercial office, are likely to fall within the title deeds . transfer of a going concern (TOGC) rules . Broadly this means that the transfer of the property is not a HOW IS LAND TRANSFERRED? supply and so is outside the scope of VAT . Certain A typical sale and purchase transaction is a conditions must be satisfied for TOGC treatment . two-stage process involving an exchange of contracts between the buyer and the seller followed Residential property transactions are not subject by completion of the legal transfer . Once terms have to VAT . been agreed between the buyer and the seller (or their agents) the seller’s lawyer will issue a draft sale Stamp Duty Land Tax (SDLT) contract and the buyer’s lawyer will carry out due SDLT is a mandatory tax payable by the buyer of diligence, which includes carrying out searches UK land on the chargeable consideration given for relating to the property and raising enquiries of the the acquisition (including any applicable VAT) . seller . The parties to the sale are not legally bound The concept of chargeable consideration is broad until they have formally entered into the sale and will denote the cash purchase price but may contract . On exchange of contracts, a deposit is also include the value of construction works or generally payable by the buyer (between 5% and debt where debt is released or assumed (as the 10% of the purchase price) which is usually held by case may be) . the seller’s lawyer as a stakeholder . Following exchange of contracts, the parties execute a separate The acquisition of a commercial freehold or document, called a transfer, which completes the assignment of a leasehold is subject to SDLT at a transaction . The sale is then completed on the date rate of up to 4% on the chargeable specified in the contract when the balance of the consideration given . purchase price is paid to the seller’s lawyer . If the buyer fails to complete the contract, the seller may SDLT is also payable by the tenant on the retain the deposit . A letting transaction generally consideration (premium and rent) paid for the follows a similar course except that the contract is grant of a lease over UK land . The rental element is replaced by an agreement for lease and the transfer subject to SDLT at a rate of 1% of the net present is replaced by the lease document . Following value of the lease over and above a £150,000 completion, the buyer’s lawyer submits the transfer threshold . Different rates apply to the acquisition or the lease to the Land Registry for registration . of residential property .

TAX IMPLICATIONS OF ACQUIRING AN In some cases, the chargeable consideration given INTEREST IN PROPERTY for a transaction between connected persons can Value Added Tax ( VAT) be deemed to be the market value . Most commercial property transactions are There are a number of transactions that are subject to UK VAT (at a rate of 20%) as long as the relieved from SDLT, for example, transfers of land person making the supply has opted to tax the between group companies and the leaseback land and that option has not been revoked element of a sale and leaseback . Great care must or disapplied . be taken as it is possible for these reliefs to be clawed back in certain circumstances . HERBERT SMITH FREEHILLS ACQUIRING AND INVESTING IN PROPERTY 105

A tax return (called a land transaction return) must the disposal of a UK high value (over £2 million) be submitted to HMRC within 30 days of the residential property by certain non-resident effective date of the land transaction . The return corporate vehicles . requires a wide range of information to be supplied to HMRC and is necessary for both residential and The UK also has a real estate investment trust commercial property acquisitions . (REITs) regime . A REIT is a property investment vehicle, which is exempt from tax on income and The relevant SDLT rates can be found in gains arising from its property rental business . Chapter 13 . Special rules need to be complied with in order to qualify as a REIT . Annual Tax on Enveloped Dwellings (ATED) Construction industry scheme ATED is an annual tax charge for high value residential properties held in certain HMRC compulsorily requires some building corporate vehicles . contractors (or people treated as contractors) to register for the construction industry scheme . It applies as of April 2013 to residential properties Failure to register when required to do so means worth over £2 million and is to be extended to that the contractor can only be paid with a 20% residential properties worth over £1 million with (or in some cases 30%) deduction of tax . Similarly, effect from April 2015 and worth over £500,000 there is a broad obligation on customers of with effect from April 2016 . building contractors to confirm that their suppliers are registered and to make the necessary Tax on income from real estate and withholdings if not . Registration should take place property disposals before any payments are made . The scope of these rules is broad and they can apply to Income derived from ownership of UK land may many transactions involving or related to result in UK tax liabilities, even for non-residents . construction work . Non-resident companies will generally be subject to UK income tax (at a rate of 20%) on rents Capital allowances received from UK investment property . Non-residents in receipt of rents from UK real Ordinarily, the UK tax system does not allow for estate must also comply with the non-resident tax relief on capital (as opposed to revenue) landlord scheme . Under these rules, tenants or expenditure save for expenditure which qualifies paying agents must withhold 20% of the rent and for relief under the capital allowance regime . remit that sum to HMRC on account of the Broadly, the capital allowances regime provides a non-resident landlord’s UK tax liability unless the tapered (over time) relief for capital expenditure non-resident landlord has obtained advance incurred on the acquisition of certain items such as clearance from HMRC to be paid gross . Certain some plant and machinery and fixtures . It is in conditions must be satisfied before clearance will essence, tax depreciation . Great care needs to be be given . taken to ensure that capital allowances are properly documented when an asset qualifying for A non-resident company will generally have no UK relief is acquired or transferred . tax to pay on disposal of a commercial investment property . However, with effect from April 2013, there is a charge to UK tax on any gains made on 106 CHINA’S OVERSEAS INVESTMENT RULES HERBERT SMITH FREEHILLS

24. C HINA’S OVERSEAS INVESTMENT RULES China encourages competitive Finally, foreign exchange cannot be remitted out of China until the overseas investment is domestic enterprises to invest in and registered with SAFE (although, subject to a run overseas enterprises . China also filing with/approval by the NDRC and approval by permits limited indirect overseas SAFE, funds for certain initial expenses may be remitted out of China prior to approval or filing of investment, such as overseas the transaction) . securities investment, although this Overseas investments in the financial/insurance/ section mainly focuses on direct securities sector are also subject to at least overseas investment . two governmental approvals: one by the relevant financial/insurance/securities regulator and the OVERVIEW other by SAFE . Investments in the non-financial/insurance/ securities sector are typically subject to approvals by Approvals, if required, can take months to obtain . or filings with two governmental authorities: the Chinese overseas investors must plan well in National Development and Reform Commission advance to minimise the effect of any required (NDRC) and the Ministry of Commerce (MOFCOM) . approvals on a proposed overseas acquisition . Registration with the State Administration of Foreign Historically, the effect of the Chinese approval Exchange (SAFE) is also required . Moreover, regime has been to put Chinese overseas investors at approval by the State Asset Supervision and a competitive disadvantage in comparison to buyers Administration Commission (SASAC) or the that are not subject to such approvals . It has not been Ministry of Finance (MOF) may be required – in unusual for sellers to require a “China premium” to addition to the above approvals – if the overseas compensate them for the additional time required for investment involves Chinese state-owned assets . approvals and the risk that a particular investment might not be approved . Without the required approvals, filings and registrations, overseas investments cannot proceed . More recently, China has begun relaxing its approval system . In December 2013, China’s State Council Firstly, for projects subject to approval by or filing issued the Catalogue of Investment Projects Subject with the NDRC, the parties must either: (i) obtain to the Approval of Government (the New Catalogue) . approval or complete a filing before signing the As outlined below, the New Catalogue indicates that definitive transaction documents; or (ii) explicitly many overseas investment projects will be subject to agree in the definitive transaction documents that filing with the NDRC; previously, many of these the validity of the documents is subject to the transactions were subject to NDRC approval . The approval by or filing with the NDRC . Approval by or NDRC has issued implementing rules for the New filing with the NDRC is also a prerequisite for the Catalogue, and MOFCOM has circulated draft relevant processes with SAFE, customs, entry-exit implementing rules for public comment . administration authorities and the tax bureau, and for releasing loans .by financial institutions . Policy statements issued early 2014 indicate that Secondly, investments that are subject to approval administrative processes for outbound investment by MOFCOM cannot go ahead without will continue to be simplified, and that additional MOFCOM’s approval or filing with MOFCOM . financial and taxation support may also be expected . HERBERT SMITH FREEHILLS CHINA’S OVERSEAS INVESTMENT RULES 107

PRIORITY INVESTMENTS & investors or accelerate the exploration of PREFERENTIAL POLICIES international markets; UK investments in the following sectors are projects arising from bilateral or multilateral considered important, and may receive economic cooperation between different preferential treatment regarding foreign exchange, governments; and tax and customs: overseas project companies established by certain biopharmaceuticals; state-owned enterprises . computer manufacturing; The above key overseas investments are also eligible trade and distribution; to obtain special overseas investment insurance storage; coverage (including for political risks and financial risks), risk-consulting services and project finance transportation; provided by the China Export & Credit Insurance Corporation and the China Development Bank . research and development; finance/insurance/securities; and Other investments may also be eligible for support with taxation, foreign exchange and customs, legal consultancy. although such support is subject to satisfactory performance of the overseas investment as assessed Special loans at discount interest rates and other during annual inspections by MOFCOM and SAFE . financial services provided by the China Development Bank and the China Export and Import On its official website, MOFCOM publicises Bank are also available to support the following key overseas investment intentions of Chinese investors . overseas investments: MOFCOM also provides overseas investment resource development projects needed to services to Chinese investors, among other things, supplement domestic resources; collecting information on a potential target country, assisting with Chinese investors’ production and infrastructure projects facilitating complaints regarding overseas investments, and the export of domestic technologies, products, providing guidance for investors to invest in a equipment and labour services; particular country . production and infrastructure projects using resources to guarantee loan repayments; The use of RMB in outbound investment is also currently being promoted . At present, a mainland research and development centres utilising non-financial institution may adopt an RMB fund international advanced technology or pool for offshore lending if: management experience or being equipped with international experts; it invests in the offshore recipient or is ultimately controlled by the same parent company; and acquisitions or mergers that can improve the international competitiveness of Chinese investors or a member institution exercises the functions accelerate the exploration of international markets; of a regional headquarters or provides investment management . construction contracting projects that can improve the international competitiveness of Chinese 108 CHINA’S OVERSEAS INVESTMENT RULES HERBERT SMITH FREEHILLS

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PROHIBITED INVESTMENTS A joint venture structure between the foreign seller and the Chinese investor has been used in a number An investment into the UK will be prohibited by of overseas investments . China if it: endangers China’s sovereignty, security or public APPROVALS/FILING REQUIREMENTS interest, or violates Chinese laws and regulations; FOR INVESTMENTS IN THE NON-FINANCIAL/INSURANCE/ impairs China’s relationship with other countries SECURITIES SECTOR (regions); The NDRC has approval authority concerning is likely to violate any international treaty overseas investments in sensitive states, regions, or concluded by China; or sectors, and investments of US$1 billion or more that do not need approval by the State Council . involves any technology or product that is MOFCOM, on the other hand, only has approval prohibited from being exported out of China . authority concerning investments in sensitive states, regions or sectors . In other cases, filing with the STRUCTURING A DEAL two authorities is required . Chinese investors typically look overseas to increase their access to foreign technology, to leverage an SAFE registers overseas investments . Based on such established foreign brand, to limit their exposure to registration, foreign exchange can be remitted protectionist trade actions by foreign governments abroad . Approval from SASAC or MOF may also be or simply to take advantage of a good opportunity . required if the Chinese overseas investment involves Chinese investors in the resources sector have been state-owned assets . active for the purpose of securing a long-term supply of natural resources for consumption in China .

Some of the key points commonly arising in negotiations include: Licensing of trademarks – a Chinese investor will typically want to ensure post-acquisition access to the foreign brand . The foreign seller may wish to secure royalties . Access to patents and other technology – technology arrangements can be complex with patents and other technologies being shared with other group companies of the seller . Seller support during a (lengthy) transition period – a Chinese investor with limited overseas investment experience is likely to need assistance to establish its control of the new business . The foreign seller, however, will be keen to limit its exposure . HERBERT SMITH FREEHILLS CHINA’S OVERSEAS INVESTMENT RULES 109

NDRC APPROVAL/FILING REQUIREMENTS The following table summarises the NDRC approval/filing requirements:

CHINESE INVESTMENT APPROVAL/ INVESTOR REGION/SECTOR AMOUNT FILING AUTHORITY All In sensitive states, regions Less than Approval NDRC or sectors* US$2 billion All In sensitive states, regions US$2 billion Approval State Council or sectors* or more (NDRC must give its opinion on such projects) All Not in sensitive states, US$1 billion Approval NDRC regions or sectors* or more Centrally- Not in sensitive states, Less than File for record NDRC administered regions or sectors* US$1billion investor Non-centrally- Not in sensitive states, US$300 million File for record NDRC administered regions or sectors* or more and investor less than US$1billion Not in sensitive states, Less than File for record Provincial- regions or sectors* US$300 million level NDRC

* Sensitive states and regions refer to the countries and states that have not established diplomatic relations with China or that are subject to international sanctions, or countries and regions at war or experiencing civil unrest.

Sensitive sectors include but are not limited to basic mutual benefit and development; possible telecommunications operations, cross-border prejudice to national sovereignty, national security, development and utilisation of water resources, and public interest; and compliance with large-scale land development, power grids and international treaties or conventions to which news media . China is a party; China’s administration of capital accounts; and The NDRC will take the following matters into account when deciding whether or not to approve an investment strength of the investor . application to invest overseas: The NDRC is required to respond within 20 working compliance with PRC law, industrial policy and days from its acceptance of an application for outbound investment policy; approval . An extension of 10 working days is 110 CHINA’S OVERSEAS INVESTMENT RULES HERBERT SMITH FREEHILLS

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allowable . Additional time may also be taken if the centrally-administered companies just need to file NDRC decides to designate a consulting institution to with MOFCOM, and non-centrally administered assess the overseas investment . For filings, the companies with provincial governments . NDRC is required to respond within seven working days from its acceptance of the filing application . In April 2014, MOFCOM released the draft of Administration Measures on Outbound Investment NDRC approval or filing with NDRC is also required for public comment . The draft measures are for the remittance by a Chinese investor of certain intended to fully implement the New Catalogue . initial expenses . Such approval or filing may be Under the draft measures, MOFCOM or its local sought before the Chinese investor applies for branches would be required to review a filing approval or filing of the overseas investment itself . application within three working days from The amount of the initial expenses, however, will be acceptance of the application . MOFCOM would also taken to form part of the total Chinese investment . be required to make a decision on an application for approval within 15 working days from acceptance of In addition, an overseas acquisition or bidding the application . As of the time of writing this chapter, concerning more than US $300 million in Chinese it is unclear when and in what form the investment must be pre-reported to the NDRC . The administrative measures will be issued . In the pre-report to the NDRC is required before: (i) any meantime, the recently-published list of MOFCOM binding agreement is signed; (ii) any binding price is approvals indicates that MOFCOM will only exercise offered; (iii) any application to the host country’s the approval powers set out in the New Catalogue . supervision authority is made; and (iv) any formal As a result, various uncertainties remain for tender is submitted, in relation to the overseas the moment . investment . For the projects that comply with China’s industrial policy, the NDRC will issue a confirmation An approval certificate (or a filing receipt) issued by letter within seven working days . MOFCOM or its provincial-level branch (as applicable) is required for subsequent foreign If a Chinese investor intends to make its investment exchange and various other registrations . in an overseas company in the form of property in kind (including material objects, intellectual property, In addition, MOFCOM and SAFE require a Chinese technology, shares or creditor’s rights), the value of investor to submit a report as soon as the Chinese such investment must be decided in accordance with investor forms an intention to merge with or acquire the appraised value or the fair value of such property . an overseas entity and before the Chinese investor An asset appraisal report issued by a China-qualified carries out the overseas investment . asset valuation institution, an audit report by an accounting firm, a confirmation letter by a competent SAFE REGISTRATION institution or other document issued by a third party SAFE plays multiple roles in overseas investments: confirming the value of such property must be submitted to the NDRC for review . Foreign exchange registration and remittance – SAFE registers overseas investment once an MOFCOM APPROVAL/FILING overseas investment project has been approved by REQUIREMENTS (or filed with) the NDRC and MOFCOM . Without Under the New Catalogue, MOFCOM approval is SAFE registration, foreign exchange cannot be only required for starting up a business in a sensitive remitted abroad . state, region or sector . In other circumstances, HERBERT SMITH FREEHILLS CHINA’S OVERSEAS INVESTMENT RULES 111

Outbound investment may be funded from the SUPERVISION Chinese investor’s own savings, from the purchase MOFCOM, along with other competent authorities, of foreign exchange, from foreign exchange loans has established a “bad-record filing system” . The provided by banks incorporated in China, from system is aimed at keeping track of any bad in-kind contributions, intangible assets or, if behaviour of Chinese investment overseas . In approved by SAFE, another foreign exchange particular, the system will keep a record of: source . Profit accrued from outbound investment may be deposited with banks abroad and used to unfair competition activities of the overseas fund outbound investment . The Chinese investor is entities, including but not limited to commercial required to submit an explanatory statement bribery, bid rigging, unfair price competition, regarding the source of funds as part of its defaming other competitors, and false application materials submitted to SAFE for the representation; and registration of the overseas investment . failure to comply with the host country’s Overseas account opening – SAFE registration is laws and customs and any damage caused to the required if the Chinese investor needs to open an local environment . overseas account . China’s diplomatic and consular missions as well as Post-investment supervision – See “Annual other competent organs are responsible to collect Inspections” below . information regarding bad behaviour and report to MOFCOM . Records of the punishment imposed on Initial expenses may be remitted out of China prior to the companies by administrative decisions or judicial the transaction being approved by the relevant organs will be published, while the other records will Chinese authorities . Such initial expenses generally be reserved and shared among certain authorities may not exceed 15% of the planned total investment for reference . (if the initial expenses exceed 15% of the planned total investment, special SAFE approval of such initial A bad record relating to unfair competition will bar expenses will be required) . The balance of the the entity from enjoying any favourable policy initial-expense funds must be repatriated to China if support from the state for a period of three years . the transaction is not approved by the Chinese authorities within six months from the date of the In addition, MOFCOM and the Ministry of remittance of such initial-expense funds . The Environmental Protection have issued guidance on six-month period for remittances may be extended environmental protection and on intellectual up to 12 months . property rights in an effort to guide the behaviour of Chinese companies overseas . An overseas company established by a Chinese investor may raise funds in the target country . ANNUAL INSPECTIONS However, unless otherwise approved by SAFE, neither the Chinese investor nor any Chinese MOFCOM, together with SAFE, conducts annual domestic bank or other Chinese domestic entity may inspections of overseas companies established by provide foreign exchange guarantees in any form for Chinese investors (excluding central such overseas company . government-controlled enterprises and financial/ insurance/securities companies) from 1 June to 112 CHINA’S OVERSEAS INVESTMENT RULES HERBERT SMITH FREEHILLS

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31 July each year . They also regulate various investment from the Shanghai FTW will, however, post-investment matters . still be subject to NDRC and MOFCOM approvals .

Centrally-administered enterprises themselves, in In addition, enterprises registered in the Shanghai coordination with SAFE, conduct annual inspections FTZ enjoy more relaxed financial policies, including: of their own overseas investments . Annual SAFE approval is not required for overseas inspection reports must be submitted to MOFCOM guarantees and payment of guarantee and SAFE before 15 September each year . The annual fees overseas; inspection certificates are needed for various subsequent registrations and formalities . the maximum amount of foreign exchange loans that can be lent overseas is 50% of the lender’s Annual inspection results are categorised as Grade 1, equity, compared to the 30% for enterprises Grade 2 and Grade 3 . Only those overseas registered outside the Shanghai FTZ; and investments falling into the Grade 1 category will be an eligible enterprise registered in the Shanghai entitled to various preferential treatments for FTZ may open a foreign exchange account for overseas investments in the following year . If any international cash pooling that: (i) does not restrict overseas investment falling into the Grade 3 category foreign exchange transfers with offshore accounts; fails to improve its grading in the next year, the and (ii) freely allows transfers to and from its main relevant Chinese investor may not conduct any new domestic foreign exchange account . overseas investment for a period of one year .

SHANGHAI FREE TRADE ZONE In addition, the Shanghai FTZ regulations provide that overseas investments by individuals will be The Shanghai Free Trade Zone (FTZ) was facilitated . Specifically, individuals who are employed established in late 2013 . In addition to facilitating within the Shanghai FTZ and who meet certain foreign trade, the Shanghai FTZ was established as a requirements should be able to make securities trial ground for various reforms . Reforms that are investments and other types of overseas investment . deemed successful in the Shanghai FTZ will then be Industrial and commercial sole proprietors within the rolled out in other parts of China . Shanghai FTZ should also be able to provide cross-border loans for their respective offshore As expected of a free trade zone, establishment in operating entities . the Shanghai FTZ confers various trade, customs and tax benefits . However, the benefits also include more Implementation rules of the Shanghai FTZ flexible approach to overseas investment, a matter of regulations have not yet been issued, and it seems particular interest to Chinese investors . that individuals may need to wait for the implementing rules before being able to invest Investment overseas from an entity established in outside China . Companies should consider a range of the Shanghai FTZ will generally only be subject to a issues, including taxes imposed on the flow of funds filing (not approval) process with the Management between the Shanghai FTZ and other areas in China, Committee of the Shanghai FTZ, which acts on when considering whether to use the Shanghai FTZ behalf of the NDRC and MOFCOM . Some overseas for outbound investment purposes . HERBERT SMITH FREEHILLS CHINA’S OVERSEAS INVESTMENT RULES 113

SASAC AND MOF APPROVALS SASAC (or MOF) registration must be carried out within 60 days of the obtaining of the relevant Overseas investments using state-owned assets are Chinese government approvals or of the subject to SASAC approval and supervision – in incorporation of such branch, as the case may be . addition to NDRC and MOFCOM approval/filing and SAFE registration . If the Chinese investor is subject to Title registrations must also be filed with the MOF the direct governance and supervision of the MOF (or its relevant branch) . The following material events rather than SASAC, then it may need to obtain of overseas companies under the supervision of MOF’s approval . central or local government will then be subject to approval by the MOF (or its relevant branch) or the If an enterprise is administered by the central State Council (if applicable): government, then its investments will be subject to overseas bond issuance, stock issuance, listing and an additional range of restrictions, including other financing activities; the funds raised by the conforming its investments to state policies for overseas companies through borrowings and bond overseas investments and having any investment issuance may not be repatriated to China; outside its core industry being subject to additional approvals . Moreover, centrally-administered investments exceeding 50% of the net assets enterprises are required to formulate an overseas value of the overseas companies; investment management system and file the same any change in the share capital of the overseas with the SASAC, and prepare and file an annual companies; overseas investment plan . transfers of state-owned property or equity For overseas investments of state-owned assets interests to foreign parties if this results in the loss generally, appraisals and title registrations play an of a controlling position; important role in the government’s effort to prevent any division, merger, restructuring, sale, dissolution the stripping of state-owned assets . or bankruptcy application of the overseas Appraisal of in-kind property – state-owned companies; and property in kind to be invested overseas must be other material events of the overseas companies . appraised by a qualified appraisal institution and verified by SASAC/MOF (or their relevant The MOF (or its relevant branch) or the State Council provincial-level branch, as applicable) . The (if applicable) will decide whether to approve such appraised value confirmed by SASAC/MOF will material events within 10 working days from its generally form the basis of the investment value . receipt of the required documents . Filing with the Title registration – title registration with SASAC (or MOF (or its relevant branch) will suffice in the MOF) (or the relevant provincial-level branch, as following events: applicable) in respect of state-owned assets the accumulated amount of reinvestment by the invested overseas is required both prior to and overseas company is less than 50% of its net asset after the investment . In the event of any material value; or change of the overseas company (eg, increase or decrease of the state-owned investment in the any “material event” has occurred to a subsidiary overseas company) or where an overseas of the overseas company and not to the overseas company sets up branches or obtains a controlling company itself . position in a project by way of re-investment, 114 CHINA’S OVERSEAS INVESTMENT RULES HERBERT SMITH FREEHILLS

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APPROVALS FOR INVESTMENTS IN THE FINANCIAL/INSURANCE/ SECURITIES SECTOR Financial/insurance/securities institutions are required to obtain approval issued by the financial/ insurance/securities regulatory authorities in China before making overseas investments in the financial/ insurance/securities sector .

The financial/insurance/securities regulatory authorities in China are: the China Banking Regulatory Commission (CBRC) for the financial sector; the China Insurance Regulatory Commission (CIRC) for the insurance sector; and the China Securities Regulatory Commission (CSRC) for the securities sector .

Each of these authorities has a broad discretion as to which Chinese investors and which overseas investments they will approve . The authorities are also responsible for supervising and regulating various aspects of an overseas investment in the financial/insurance/securities sector .

SAFE registration and MOF/SASAC approvals are also applicable to overseas investments in the financial/insurance/securities sector . HERBERT SMITH FREEHILLS APPENDIX OF ABBREVIATIONS 115

APPENDIX OF ABBREVIATIONS

ADR CGT EEA GAAR Alternative Dispute Capital Gains Tax European Economic Area General Anti-Abuse Rule Resolution CIRC EMR GB AGM China Insurance Regulatory Electricity Market Reform Great Britain Annual General Meeting Commission (PRC) EU GM AIM CMA European Union General Meeting Alternative Investment Competition and Markets Market Authority EUMR HR European Union Merger Human Resources ATE CMC Control Regulation After the Event Insurance Case Management HRA Conference FATCA Human Rights Act 1998 ATED Foreign Account Tax Annual Tax on Enveloped CPF Compliance Act (USA) HMRC Dwellings Carbon Price Floor Her Majesty’s Revenue FCA & Customs ATVOD CPR Financial Conduct Authority Authority for Television Civil Procedure Rules 1998 IAS On-Demand FFI International Accounting CSMAD Foreign Financial Institutions Standards B2B Directive on Criminal Business to Business Sanctions for Insider Dealing FOIA IFRS and Market Manipulation Freedom of Information International Financial BEPS Act 2000 Reporting Standards Base Erosion and Profit CSRC Shifting China Securities Regulatory FPC IP Commission (PRC) Financial Policy Committee Intellectual Property BPA Business Purchase DECC FRI IRS Agreement Department of Energy and Full Repairing and Internal Revenue Service Climate Change (formerly Insuring Lease (USA) BTE part of the Department for Before the Event Insurance Business Enterprise and FSA ISP Regulatory Reform (BERR) Financial Services Authority Internet Service Provider CBRC and the Department for China Banking Regulatory Environment Food and Rural FSMA LIBOR Commission (PRC) Affairs (Defra) and prior to Financial Services and London Interbank that the Department of Trade Markets Act 2000 Offered Rate CCTV and Industry (DTI)) Closed-Circuit Television FTT LLP DPA Financial Transactions Tax Limited Liability Partnership CFC Data Protection Act 1998 Controlled Foreign Company FTZ MAD Rules ECEF Free Trade Zone Market Abuse Directive European Code of Ethics for CfDs Franchising GAAP MAR Contracts for Differences Generally Accepted Market Abuse Regulation Accounting Principles 116 APPENDIX OF ABBREVIATIONS HERBERT SMITH FREEHILLS

APPENDIX OF ABBREVIATIONS

MOF OHIM SDRT UK Ministry of Finance (PRC) European Office for Stamp Duty Reserve Tax United Kingdom (Great Harmonisation in the Britain and Northern Ireland) MOFCOM Internal Market SE Ministry of Commerce (PRC) Societas Europaea UKCS PAYE (European Company) United Kingdom NCA Pay As You Earn (for Continental Shelf National Crime Agency income tax) SGA Sale of Goods Act 1979 UKLA NDRC POCA United Kingdom National Development and Proceeds of Crime Act 2002 SI Listing Authority Reform Commission (PRC) Statutory Investment PRA UNCITRAL NEST Prudential Regulation SLC United Nations Commission National Employment Authority Substantial Lessening on International Trade Law Savings Trust of Competition PRC US or USA NFFEs People’s Republic of China SPA United States of America Non-Financial Share Purchase Agreement Foreign Entities R&D UTCCR Research & Development SRT Unfair Terms in Consumer NGNs Statutory Residence Test Contracts Regulations 1999 New Global Notes REIT Real Estate Investment Trust SYSC VAT NIC Systems and Controls Value Added Tax National Insurance RMB Contributions Renminbi (currency in PRC) TFEU Treaty on the Functioning of NSS RO the European Union New Safekeeping Structure Renewables Obligation TOGC OECD ROC Transfer of a Going Concern Organisation for Renewables Obligation Economic Co-operation Certificates TUPE and Development Transfer of Undertakings SAFE (Protection of Employment) OFCOM State Administration of Regulations 2006 Office of Communications Foreign Exchange (PRC) UCTA OFGEM SASAC Unfair Contract Terms Office of Gas and Electricity State Asset Supervision and Act 1977 Markets Administration Commission (PRC) UILs OFWAT Undertakings In Lieu of Water Services SDLT a Reference Regulation Authority Stamp Duty Land Tax

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