“All Reasonable” and “best” endeavours - how far must you go?

Thu, 19 Jul 2012 17:16:01 +0100

Every contract should have something to say about the lengths to which the parties must go in order to meet their obligations.

Some aspects – like service delivery – will usually be fundamental and so the requirement to comply will be absolute. Others – such as relations with third parties, governance and remediation – may be less clear cut. For commitments like these, it may only be feasible to “endeavour” to do what’s required.

I’ve written previously about the sliding scale of effort, from “reasonable endeavours” at one end, through “all reasonable endeavours” to “best endeavours” at the other (you can read that post here).

The arguments have recently been addressed again by the Court of Appeal in Jet2.com Ltd v Blackpool Airport Ltd (2011) EWCH 1529 (Comm), a case from last year which was only reported in April.

The key take-away is that a requirement to use “all reasonable endeavours” can operate to force a party to act contrary to its own commercial interests.

In this case the parties had signed an agreement in 2005 for flights to and from Blackpool Airport. The agreement was straightforward and the key clause said simply this: “Jet and BAL will co-operate together and use their best endeavours to promote Jet’s low cost services from Blackpool Airport and BAL will use all reasonable endeavours to provide a cost base that will faciliate Jet’s low cost pricing.”

All went well for the first few years. In particular, BAL allowed Jet to schedule flights outside its published operating hours (which were not mentioned in the agreement) so that it could run as many as possible each day.

However, when new owners took over BAL they decided it was uneconomic to keep the airport open for Jet’s additional flights and instisted Jet divert them elsewhere. The case turned on the construction of “best endeavours” and “all reasonable endeavours” (which, interestingly, the parties agreed should be treated the same) and whether BAL was entitled to put its own financial interests before that of its commitment to Jet.

The key points from the judgment are as follows:

• the extent to which a party who has agreed to use all reasonable endeavours can have regard to its own financial interests will depend on the nature and terms of the contract;
• the obligation to use best endeavours to promote Jet’s business required BAL to do all that it reasonably could to enable that business to succeed and grow, and this included keeping the airport open to accommodate flights outside normal hours even though this was financially detrimental;
• the initial intention of the parties could not have been for BAL to change what it did at short notice based on what profit it was making as a whole - its profits were affected not just by Jet’s flights but by various other problems it faced and which it should have considered before entering into the agreement (it had in fact been loss-making since opening);
• a party under an obligation to use all reasonable endeavours cannot use cost or inconvenience as grounds for not doing something where performance is under its control and does not depend on cooperation from a third party.

The practical implications of the case are that if possible, rather than relying on generic drafting, parties should specify what steps each is required to take and when.

When taking on an endeavours obligation, the obligor should look to exclude anything which might go beyond ‘reasonable’.

It is always prudent to say so if an obligation is not intended to force a party to act against its own commercial interests.

Further practical guidance is included at the bottom of my previous post on this area, which you can read here.

Mitigating loss under English Law - Bulkhaul v Rhodia and Linklaters v McAlpine

Sun, 2 Oct 2011 18:37:43 +0100

It’s a long standing principle of English law that when there’s a breach of contract the injured party can claim damages.

The basic premise is simple: damages put the injured party in the position it would have enjoyed had the contract been properly performed. (You can read my previous post about damages here.)

Sometimes the amount a party can claim is pre-agreed in the contract (what are called ‘liquidated damages’). But more often this is one of the things the Court will decide, once it’s adjudicated on liability – and in this situation the injured party’s entitlement is qualified by a ‘duty to mitigate loss’. What this means is that it can’t simply stand by as losses accumulate, expecting to recover them all in full. The law requires an injured party to take reasonable steps to limit the consequences of the defendant’s misbehaviour.

An important question therefore arises: just how far does this ‘duty to mitigate’ go? Two important points govern the answer.

The first is that a claimant can’t recover for losses that were avoidable. So, for example, if a buyer wrongly terminates a contract for the sale of goods, the seller will be expected to try to sell them to someone else. The claimant won’t be able to recover the full price under the broken agreement if the buyer can show there is a demonstrable ‘market’ for the goods in question, and a market value at which the claimant could have made good its loss. (This might be easier to show for widgets than for specialist or bespoke items, of course, but you get the picture.)

The second point is that claimants will usually claim for every last nickel and dime. Superficially this is obvious (why would they not?), but it’s also the consequence of an important matter of law: namely, that the burden of proving that losses are not claimable lies with the defendant. In other words, it is for the defendant to prove that the claimant could (and should) have avoided them.
Generally, the Court will be sympathetic to an injured party’s efforts to deal with a breach, particularly when decisions have to be made – often very quickly – by a claimant with imperfect knowledge. But the Court will still penalize a claimant where it has demonstrably failed to take reasonable steps, or where its actions were inadequate.
Two recent cases illustrate these points nicely. A Court of Appeal case from 2008, and a Technology and Construction Court case from earlier this year.

The 2008 Court of Appeal decision, Bulkhaul Ltd v Rhodia Organique Fine Ltd, is a good example of a claimant failing to take reasonable steps to mitigate losses.

Bulkhaul leased tanks for the transport of corrosive chemicals. Rhodia was a chemical manufacturer. Under a ten year agreement Bulkhaul leased tanks to Rhodia for the transport of hydrofluoric acid. Half way through the contract Rhodia purported to terminate it, having decided to stop manufacturing the chemical. There was a dispute over whether the contract was for a fixed-term or whether Rhodia could terminate early. Bulkhaul got summary judgment on liability but then had to quantify its loss (which it claimed in the form of unpaid rent for the remainder of the 10 year term).

Looking at whether Bulkhaul had taken reasonable steps to mitigate its loss, the Court considered whether it could have sold or leased the tanks to someone else (i.e. whether there was a market for tanks of this sort after they’d been in use for five years).

Bulkhaul said the tanks could only be used for the transport of hydrofluoric acid and that re-sale was unlikely because manufacture of the chemical was being phased out. Rhodia disagreed.
• It put forward evidence that while manufacture of hydrofluoric acid was indeed declining in some parts of the world, it was still being produced and transported in others;
• Before terminating, Rhodia had identified a third party interested in acquiring the tanks and had sought to broker a sale as a means of consensual termination – but the deal had foundered on Bulkaul’s demands over price.
• Discussions on a sale had continued post-termination, but when Bulkaul refused to lower its terms the potential purchaser had eventually acquired tanks from another source.
• During the course of the litigation Rhodia appeared to have made efforts to find other potential purchasers, but Bulkhaul’s conduct had effectively priced the tanks out of the market.
• The tanks had been manufactured with a life expectancy of ten years and had had five or six years of use remaining at the point when the contract was terminated.

On the evidence the Court decided there was indeed a market for the tanks and that Bulkhaul should have mitigated its loss by taking steps to sell or re-lease them. It assessed a market price at the level of the offer made by the purchaser Rhodia had identified, minus the cost of sale. Baulkhaul was not entitled to claim this sum back.
...
In the second case, Linklaters Business Services v Sir Robert McAlpine Limited, McAlpine were engaged as main contractor for the redevelopment of Linklaters’ London offices. Part of the work involved installing chilled water pipes. Ten years after Linklaters moved into the building one of the pipes sprang a leak. An investigation revealed severe corrosion throughout the building. On the advice of an engineer, Linklaters decided to replace the pipes wholesale rather than merely repair them. It sued for the cost of the work (which the Court agreed had become necessary because of corrosion resulting from poor workmanship by a subcontractor).  When it discovered the problem Linklaters had had two options: either to repair the pipes (the cheaper alternative) or replace them. The question was whether the decision to replace was reasonable. The Court decided that it had been reasonable and therefore that the cost of the work was recoverable.
In reaching its decision, the Court considered the following points:
1. Repair works were required come what may because the pipes could not be left untreated. Linklaters were under a full repairing and insuring lease and had contractual obligations to maintain their premises to a high standard – so any rectification work needed to satisfy their landlord. They had acted on the advice of an experienced mechanical and electrical engineer who had said there was no practical, technical or commercial alternative to replacement – and there was no good reason to ignore him. The alternative (repairing rather than replacing) would have been only a partial solution, which was risky. The option of replacing the pipework had the advantage of certainty in that all defects would be remedied.
2. The duty to mitigate is not a heavy one. In most cases it simply requires the claimant not to act unreasonably in the context of incurring loss. The burden of proving that the claimant has not done so is on the defendant.
3. Each case depends on its own facts - but, in considering 'reasonableness', the court will look at all the facts and, in particular, the circumstances in which the innocent claimant finds itself at the time when it commits to a particular course of remedial action.

Macmillan Ordered to Pay Out £11 million After SFO Bribery Investigation

Mon, 25 Jul 2011 10:18:04 +0100

Renowned publisher Macmillon has been ordered to pay more than £11 million following a Serious Fraud Office (SFO) investigation into claims of bribery in South Sudan (you can view the full SFO report here).

The company admitted that a representative of Macmillan Education made “improper and unauthorised payments” to local officials in Sudan connected with an unsuccessful bid for a multimillion-pound contract to print English language teaching and school curriculum materials.

The tender was part of a $46 million project to develop the school curriculum, train thousands of teachers and build 100 schools.

Millions of dollars of international aid have been pumped into south Sudan through a multi-donor trust fund managed by the World Bank, established in 2006 to fund post-conflict reconstruction after two decades of civil war.

The World Bank reported that an agent for Macmillan had made an attempt “to pay a sum of money with the view in mind of persuading the award of a World Bank funded tender to supply educational materials in Southern Sudan”. Macmillan has been banned from World Bank contracts for six years and must also pay £27,000 of the SFO’s costs.

Macmillan said it “deeply regretted” what had happened. “Fortunately, it has been established that these issues were confined to a limited part of our education business in East and West Africa,” said Macmillan chief executive Annette Thomas.

The Macmillan case predated the new Bribery Act, which only came into force on 1 July this year, but it demonstrates a hardening of approach by the SFO to enforcement. Under the Bribery Act, commercial organisations can be held liable for bribes paid by those acting on their behalf anywhere in the world. One key point is that Macmillan self-reported the bribery allegations, which enabled it to avoid criminal charges.

Founded by the grandfather of former British Prime Minister Harold Macmillan, the company built its reputation on big name Victorian authors such as Rudyard Kipling and Lewis Carrol. Now owned by a German publishing group, it has grown a very successful textbook printing business in recent decades.

Outsourcing In Financial Services

Thu, 14 Jul 2011 11:16:21 +0100

Financial institutions have a vast array of contracting arrangements unique to the sector, ranging from trading platforms to back office settlement functions, from funds’ administration to information systems.

The divide between mainstream outsourcing and pure financial services is not always obvious (even if most outsourcing lawyers would recognise contracts for network services, applications support or IT provision within a financial services firm). The practical importance of the divide is the blend of legal skills required and in particular the need to understand both the financial services market and outsourcing more generally. To use a very simple example, different skills will apply to an investment management contract (which will be primarily a matter of financial services law) as opposed to a network services agreement (which will be more in the way of a mainstream commercial outsourcing).

The regulatory environment

Financial services regulation in the UK has always been concerned with the systems and controls of firms carrying on financial services activities. With the trend towards increased integration of the European financial services market this area has naturally been affected by regulation at the European level.

In relation to banking law and regulation, the recommendations of the Basel Committee on Banking Supervision (the “Basel Accords”) were implemented throughout the European Economic Area by the Capital Requirements Directive (“CRD”), which in turn re-cast the Capital Adequacy Directive (“CAD”) and Banking Consolidation Directive (“BCD”). While primarily concerned with the amount of capital to be held by banks, the BCD does extend to governance arrangements, particularly management oversight, systems and controls, and the management of risk. In relation to investment services, the European Market in Financial Instruments Directive (MiFID) (which replaced the Investment Services Directive) imposes similar – though not identical – systems and controls requirements for firms undertaking investment services activities.

In the UK, the Financial Services Authority has been responsible for implementing the various requirements imposed by the above mentioned European Directives through its handbook of rules and guidance (the FSA Handbook), and in particular the “common platform requirements” contained in the FSA’s Senior Management Arrangements, Systems and Controls (SYSC) Sourcebook (which forms part of the FSA Handbook).

Rather than have separate regimes implementing CRD and MiFID, in the SYSC Sourcebook the FSA sought to establish a unified set of risk management and systems and controls requirements applying to firms generally.

The FSA Handbook has always contained a number of principles intended to be general statements of the fundamental obligations of all firms subject to the UK financial services regulatory system. These are set out in the Principles for Businesses (PRIN) Sourcebook. Principle 3 is of particular relevance to outsourcing. It requires firms to take reasonable care to control their affairs responsibly and effectively, with adequate risk management systems. In practice, any breach of the more detailed outsourcing rules in the FSA Handbook would also be treated as a breach of Principle 3, and so this principle must always be borne in mind. In essence, the provisions in the SYSC Sourcebook are the detailed development of this overriding principle.

The application of the provisions in the SYSC Sourcebook depend on the nature of the activities carried on by the outsourcing firm. There are separate provisions for insurers, insurance underwriters and the Society of Lloyd’s. For other types of firm, the application of the common platform requirements (SYSC 4 to 10) depend on whether the firm is a “common platform firm”, including banks, building societies and investment firms subject to MiFID (such as broker dealers, investment managers and financial advisers). Broadly, while SYSC 4 to 10 apply as ‘rules’ to a common platform firm, they may take effect as ‘guidance’ or not apply at all for other types of firm. It’s therefore necessary to understand exactly the regulated activities a particular firm is carrying on in order to understand the scope of its regulatory obligations.

The common platform requirements relevant to outsourcing

Although the main source of provisions affecting outsourcing are contained in SYSC 8, it’s important that an outsourcing firm doesn’t lose sight of its general regulatory obligations. This is reinforced by the fundamental principle applying to outsourcing arrangements within the scope of SYSC 8 – that an outsourcing firm remains fully responsible for discharging all of its obligations under the regulatory system (SYSC 8.1.6).

SYSC 8 applies to arrangements pursuant to which a service provider performs a process, service or an activity (which would otherwise be undertaken by the firm itself) relating to a critical or important operational function. An operational function will be critical or important if a defect or failure in its performance would materially impair the continuing compliance of the firm with its regulatory obligations, the firm’s financial performance or the soundness or continuity of its relevant services and activities (SYSC 8.1.4). Certain advisory services (e.g. legal advice), standardised services and the recording and retention of telephone and email communications are not considered to be critical or important for the purposes of SYSC 8. But where there is ambiguity over whether a particular outsourcing falls within the scope of SYSC 8, careful consideration should be given to the way it’s structured.

The detailed requirements of SYSC 8 are subject to the general duty to exercise due skill, care and diligence when entering into, managing or terminating any outsourcing of critical or important operational functions (SYSC 8.1.7), and the requirement to ensure the respective rights and obligations of the firm and service provider are clearly allocated and set out in a written agreement (SYSC 8.1.9).

Of course, adhering to these detailed requirements in the outsourcing contract is only one component of compliance. In practice, issues such as service provider selection feed into the procurement process, and issues around monitoring performance don’t end once a contract has been put in place. Furthermore, a cold look at the list of SYSC 8 contract issues doesn’t reveal the full extent of responsibilities. See, for example, the rules and guidance in the FSA’s Supervision (SUP) Sourcebook. A firm must take reasonable steps to ensure that a service provider deals in an open and cooperative way with the FSA in the discharge of its functions (SUP 2.3.7R). Firms must also ensure that persons performing the controlled functions specified in the FSA Handbook are approved by the FSA to perform that function, even if employed by the supplier (SUP 10.12.3G).

Generally speaking, it’s wise to inform the FSA at an early stage of any significant proposed outsourcing to give it the opportunity to raise and address any concerns. Indeed, disclosure of a proposed outsourcing may be required. Principle 11 in the PRIN Sourcebook requires firms to “disclose to the FSA appropriately anything relating to the firm of which the FSA would reasonably expect notice.” Guidance in the SUP Sourcebooks indicates that matters to be notified to the FSA include “entering into, or significantly changing, a material outsourcing arrangement”. As to what amounts to a ‘material’ outsourcing, the FSA have intentionally left this issue open-ended, stating that the materiality of an outsourcing will depend on the firm concerned, and that firms are best placed to make this determination.

The above mentioned provisions are not the only financial services regulations which may affect an outsourcing arrangement – they are merely those most directly relevant to outsourcing. Firms outsourcing their functions should not overlook the fundamental principle mentioned above applying to outsourcing arrangements within the scope of SYSC 8 – that the outsourcing firm remains fully responsible for discharging all of its obligations under the regulatory system (SYSC 8.1.6). Nor should international regulatory requirements and general law requirements be forgotten by outsourcing firms within the financial services sector. Sarbanes-Oxley, the USA Patriot Act and data protection, amongst others, may be highly relevant.

Finally, firms operating in the financial services sector should be aware that financial services regulation continues to evolve. The efforts of regulators to keep pace with changing market practices is one of the principal factors sustaining this fluidity, as are changes in approach to regulation per se.

Plans announced last year by the Chancellor will see the abolition of the existing tripartite regime between the FSA, Bank of England and HM Treasury, effectively scrapping the FSA in favour or a ‘twin peaks’ regulatory model.

At the Bank of England this will see two new bodies set up, the Prudential Regulatory Authority (PRA), which will take responsibility for regulating banks, building societies, insurers and the largest investment firms, and the Financial Policy Committee, which will oversee macro-regulation. The rest of the industry will be left in the care of the Financial Conduct Authority (FCA), which is the new name for what had previously been labelled the Consumer Protections and Markets Authority. The FCA’s strategic objective will be to protect and enhance confidence in the UK’s financial system.

Following Treasury consultation last year the FSA released a “Dear CEO” letter on the transition in January. In the letter, Hector Sants, Chief Executive of the FSA, reiterated that the PRA (which he will head) will be responsible for promoting the stable and prudent operation of the financial system through the regulation of 2,200 firms. The focus will be on ensuring that institutional failures create minimum impact for the rest of the marketplace, rather than attempting to pursue a ‘zero fail regime’.

The precise timing for creation of the new bodies remains unclear. The target date is currently mid to late 2012 but this is expected to slip into 2013.

All You Need To Know About The New Bribery Act In 5 Bullet Points

Fri, 1 Jul 2011 15:10:48 +0100

The Bribery Act 2010 comes into force today (it’s dated ‘2010’ rather than ‘2011’ because the Bill received Royal Assent last year). You can read the full text here.

There’s been a lot of press coverage about the new law, most of it focused (rather unhelpfully) on the supposed threat to corporate hospitality and the various delays which at one point put the UK at risk of an export blacklist alongside the likes of Nigeria and Russia. It’s also been criticised for putting UK companies at a competitive disadvantage. In fact, the rules simply fulfil the UK’s obligation as a signatory to the OECD Anti-Bribery Convention (which you can access here).

Here is my ‘all-you-need-to-know-about-the-new-law’ guide, in five simple bullets.

• Corporate hospitality has not been banned. Guidance on the Act makes it clear that “reasonable and proportionate” hospitality given in “good faith” will still be permitted, and so the vast majority will come nowhere near crossing the line into bribery. Only where hospitality is such as to infer an intention to influence a decision maker improperly would it fall foul of the new rules.

• The definition of bribery is deliberately broad. It covers anything which seeks to influence a decision maker by going beyond legitimate parameters for obtaining or retaining business. There are four offences: (1) bribing another person; (2) being bribed onesself; (3) bribing a foreign public official; and (4) f0r commercial organisations, failing to prevent bribery.

• The first three offences apply to individuals and to corporate bodies if a director, partner or similar senior official consents to or connives in the bribe.

• The fourth offence - failing to prevent - will be the key area for most UK companies because it makes employers liable for acts of bribery by employees, agents and other representatives, whether here or overseas. Significantly, the Serious Fraud Office will not have to prove intent by directors, but simply that fraud has been committed. As well as unlimited fines, companies found guilty may be disbarred from tendering for public contracts in the EU. The only defence is to show that “adequate procedures” have been implemented.

• Guidance on what “adequate procedures” means was published in March. It’s worth taking the time to read the guidance, which you can download here. The overriding principle is that procedures should be tailored to the risks of corruption applying to each organisation and its work. So, where the risks are minimal there is no need for complex or burdensome red tape. The guidance sets out 11 case studies, each based on six principles:
- internal and external assessment of risk;
- proportionality (by reference to risk but also to the size and complexity of the organisation);
- board-level commitment and zero-tolerance;
- due diligence (on parties performing services for or on behalf of an organisation);
- communication (of procedures, but also in relation to providing the means for whistle-blowing or ‘speak-up’ by staff); and
- monitoring and review (to maintain effective implementation).

The Bribery Act is important because the penalties can be severe - an unlimited fine and 10 years imprisonment - but it needn’t become a corporate headache if organisations take the trouble to implement appropriate compliance measures.