Can a funder be liable for refusing to provide further funds to a company?

Often limited companies are undercapitalised, relying on a funder’s willingness to lend further money when needed in order to stay solvent.  The funder is typically a holding company or the individual behind the company.  The funder may be under no legal obligation to provide further funds when required by the company, and accounts are prepared on a going concern basis on the mere expectation they will do so.

Third parties contracting with such an undercapitalised limited company would be well-advised to seek guarantees from the funder, but in practice funders are often unwilling to give guarantees.  The perils of contracting with such a company without a guarantee were revealed by the case of Palmer Birch (A Partnership) v Lloyd & Another [2018] EWHC 2316, as the judge in that case noted in his judgment.  As he went on to say, the case “also reveals less directly the potential pitfalls for those individuals who choose to operate through the medium of such a limited company which proves not to be good for its contractual obligations, including those who may have directed its affairs from the shadows (or quite openly but perhaps not quite constitutionally).”

Michael Lloyd had acquired a mansion house in Devon through a corporate structure and was refurbishing it to serve as his English home and for proposed business activities of corporate hospitality, conferences, educational purposes, shooting and grazing.  The freehold of the property was owned by Seizar Holdings Limited, a Cypriot company, which granted a 21 year lease to Hillersdon House Limited (“HHL”), an English company of which Michael’s brother Christopher was sole shareholder and director.    HHL contracted with the Palmer Birch partnership for the refurbishment at a contract sum of just over £5M.  This structure enabled HHL to recover the VAT on the building works, which Michael personally could not have done.  Michael funded the project through a £5M loan facility to HHL, which was in turn part financed with his bank.

By December 2014 the project was running over time and over budget and Michael was running out of patience and of money, though further funds were expected when a property development in Kenya produced a return on his investment.  Invoices from the contractor went unpaid and by a solicitors’ letter of 22 April 2015 HHL gave notice to terminate the building contract, purportedly on the basis of its own insolvency.  As the contract only allowed termination on the basis of the other party’s insolvency, this was of itself a repudiatory breach of contract.  Subsequently a new company, Country Sporting Experience Ltd. (“CSEL”), of which Michael was sole shareholder and director, took over the property and was funded by the eventual returns from the Kenya investment, which crucially came through just before the formal liquidation of HHL.

Unusually Palmer Birch took legal action not against the insolvent company but against its director Christopher and its funder (and arguably shadow director) Michael personally, alleging that Michael had committed the torts of inducing breach of contract and unlawful interference and that Michael and Christopher had committed the tort of unlawful means conspiracy.  Some of the claims have now succeeded on a preliminary trial of the liability issues, though damages have still to be established.

Importantly for funders, the claim failed that Michael’s failure to fund, which resulted in HHL failing to pay the sums due to Palmer Birch, amounted to his inducing a breach of contract by HHL.  The judge followed earlier cases that “the inducement tort is not committed simply through a suggested failure on the part of the defendant to feed the coffers of a limited liability company, to enable it to meet its contractual obligations, when in fact there is no legal obligation to do so”.  This is known as “mere prevention”, as distinguished from “inducement”.

However this can be a “thin dividing line” and Michael was held to have crossed it in this case by causing HHL “to repudiate the Contract, when the funds which were then made available to CSEL could instead have been made available to HHL in time to enable it to perform the Contract and to meet its contractual obligations”.  On the evidence, Michael was found to have been behind the decision to instruct the solicitors to give notice purportedly to terminate the contract and the insolvency practitioners to arrange the creditors’ voluntary liquidation of HHL, when the last minute funds had become available which he could have used to save the Contract and HHL.  The judge also found that “the evidence safely supports the inference that by no later than late January 2015 Michael and Christopher had reached an agreement to bring about the liquidation of HHL so that it might escape from the Contract and thereby avoid meeting PB's existing and anticipated claims”, which was sufficient for the claim of an unlawful means conspiracy to succeed.

The advice for funders is that yes you can set up such a structure (a claim that the setting up of the structure was itself an unlawful interference or unlawful means conspiracy had been struck out at an earlier hearing as having no prospect of success) and in principle you can withhold further funding that you are under no legal obligation to provide, even if it results in the borrowed failing to meet its contractual obligations and becoming insolvent.  But you have to be careful not to cross that “thin dividing line” and become actively involved in inducing that breach of contractual obligations - especially if you do have the funds that could have been used to comply with them.  If you do set up a structure which is run by a third party, let them get on with it and be very careful not to interfere – especially when it runs into trouble.

The advice for contractors with such companies is to seek personal guarantees from undercapitalised companies.  If they are refused, you proceed at your own risk.  Although Palmer Birch succeeded on liability for some of their claims in this case, they have still to establish quantum, and each case turns on its own facts, which can often be difficult (and expensive) to prove.

“No Oral Modification” – does it mean what it says?

“Boilerplate clauses” are a standard part of most written contracts and are rarely given much thought.  They provide the basic provisions which are considered appropriate in nearly all contracts.  A common one provides that any variation to the agreement must be in writing and signed by or on behalf of the parties.  This is known as a “No Oral Modification” clause, or “NOM”.  Its purpose is to reduce the potential for future disputes where one party seeks to argue that the other had orally agreed to their departing in some way from the terms of the written contract.  This helps create certainty (which is the point of putting contracts in writing), but the problem is that in practice the parties don’t read their contracts (and especially not the boilerplate clauses, which are considered “legalese”) and so do sometimes actually agree such oral variations, which they then proceed to act upon.

Take this example:

“All variations to this Licence must be agreed, set out in writing and signed on behalf of both parties before they take effect.”

This wording was in a licence to occupy serviced offices in central London granted by MWB Business Exchange Centres Ltd to Rock Advertising Ltd.  Rock fell into arrears and claimed to have agreed a revised payment schedule over the phone with MWB’s credit controller.  The credit controller’s boss didn’t approve the proposed payment schedule, and MWB evicted Rock and claimed the arrears.  Rock counterclaimed for wrongful eviction.  The judge found there was indeed an oral agreement to vary the licence, which the credit controller had authority to conclude, but it was ineffective as it didn’t comply with the NOM.

The case went all the way up to the Supreme Court, as there was no clear authority under English law whether NOM clauses were effective.  The general view, supported by recent cases (and by the Court of Appeal in this case), was that they were not – because the parties had freedom to contract orally and so could agree a subsequent oral contract which would impliedly override the NOM.  But lawyers still included NOMs in contracts – just in case they did work.

The Supreme Court, in Rock Advertising Ltd v MWB Business Exchange Centres Ltd [2018] UKSC 24, held 4 to 1 that NOM clauses did indeed work (so we lawyers were right to include them all along).  Lord Sumption, delivering the lead judgment, explained his view that:

“What the parties to such a clause have agreed is not that oral variations are forbidden, but that they will be invalid. The mere fact of agreeing to an oral variation is not therefore a contravention of the clause. It is simply the situation to which the clause applies. It is not difficult to record a variation in writing, except perhaps in cases where the variation is so complex that no sensible businessman would do anything else. The natural inference from the parties’ failure to observe the formal requirements of a No Oral Modification clause is not that they intended to dispense with it but that they overlooked it. If, on the other hand, they had it in mind, then they were courting invalidity with their eyes open.”

Lord Briggs disagreed with this analysis, but agreed the appeal should be allowed.  He took the view it was theoretically possible to agree orally to dispense with a NOM clause, but the Courts would only imply that the parties had done so where “strictly necessary”, rather than as a matter of course just because they had not complied with the NOM.  He therefore agreed with the majority that the oral variation was ineffective in this case.

So we now have clear authority that NOMs work, and that you can’t agree to delete them except in writing.  This is good for legal certainty, but is likely to create problems in those cases where the parties have agreed an oral variation anyway and gone ahead and acted upon it.

In such cases, as Lord Sumption pointed out, “the safeguard against injustice lies in the various doctrines of estoppel”; i.e. if something is agreed orally and one party acts in reliance on it to their detriment, the party who allowed this to happen will be “estopped” from relying on the NOM.  You might think this is the same thing as allowing oral variation of NOMs, but the subtle legal difference is that estoppel is an equitable doctrine which allows the Courts to do justice in individual cases rather than a hard and fast rule that a party can always rely on.  So the contract remains as per the written terms, but that doesn’t mean you’ll be able to enforce it if you’ve allowed the other party to believe you agreed you wouldn’t.

Downloaded software is not "Goods"

The Commercial Agents (Council Directive) Regulations 1993 provide for the payment of compensation to a commercial agent whose agency agreement is terminated by the principal without cause, even when terminated under a notice clause in the agreement.  However an important limitation is that they only apply to to agents authorised to negotiate or conclude "the sale or purchase of goods" on behalf of their principal.  Agencies to negotiate the supply of services by the principal are not covered.

So what is the position when an agency for the supply of software is terminated?  Is software "goods" for this purpose?  The Regulations, and the EU Directive which they implemented, do not define "goods".

This question came up in the case of Computer Associates UK Ltd v The Software Incubator Ltd [2018] EWCA Civ 518 decided by the Court of Appeal on 19 March 2018.  In that case Computer Associates had terminated an agency agreement to resell their release automation software, which was supplied by electronic download only, and not on disks, by way of perpetual licence.  The judge held that the Regulations should be interpreted so that "goods" included downloadable software, and that Computer Associates had wrongly terminated the agency, as the agent was not in breach of contract.  He therefore awarded the agent £475,000 in compensation for the loss of its future income stream.

Lady Justice Gloster, delivering the judgment of the Court of Appeal agreed that Computer Associates had not been entitled to terminate the agency, but disagreed that downloadable software was "goods" under the Regulations.  She referred to the earlier St. Albans and Your Response cases, which had made a distinction between software provided on physical disks and software provided by electronic download, and held that only the former constituted "goods".  She noted that the Consumer Rights Act 2015 (which implements the EU Consumer Rights Directive and now governs the sale of goods to consumers - though not to businesses) accepted this distinction as being the existing law and provided for a new category of "digital content" to give consumers equivalent rights for downloaded content to those they had for physical goods.  As the software here was not "goods", the Regulations therefore did not apply, the agent's £475,000 compensation was disallowed, and it was left with the £15,000 the judge had awarded as damages for breach of contract.

This case confirms the orthodox understanding that packaged software sold on physical disks is "goods" but software downloaded from the internet is not.  The reality nowadays is that almost all software is sold by download.  Consumers have the protection of the digital content provisions of the Consumer Rights Act 2015, but those do not apply to businesses, who cannot therefore claim that downloaded software is not of satisfactory quality under the Sale of Goods Act 1979.

In any case, much software is now supplied as a Cloud-based service, especially in a B2B context.  This will definitely not be "goods" when the sale is negotiated by an agent, but is more likely to be considered as a "service" given the way Cloud subscription agreements are typically structured.  The Commercial Agents Regulations will not apply in such cases, but the implied warranty that the supplier has used reasonable skill and care in the provision of the services under the Supply of Goods and Services Act 1982 would apply if not contractually excluded.