Claim notifications: Why less is more

• 13 October 2020
• News

Recent case law has shown that the devil is in the detail when notifying a party to a share purchase agreement of a potential claim under that agreement. It’s long been a principle of English law that a potential defendant in litigation has the right to some certainty, without the spectre of litigation looming indefinitely in respect of historic events or disputes.

In share acquisitions, this is commonly reflected in the share purchase agreement where the parties agree limitations on the buyer’s right to bring a claim against the seller for breach of warranty or under the tax covenant.

The Limitation Act 1980 sets a period of six years within which a claim must be brought if the contract is made under hand (section 5), or 12 years if the document is executed as a deed (section 8). These statutory limitation periods are usually reduced further by the parties, with buyers and sellers generally agreeing:

1. A period within which the buyer must notify the seller of any potential claim under the contract.
2. A deadline by which the buyer must have progressed any potential claim once it has been notified.

Parties will typically agree a period of anywhere between 12 and 36 months for notification of non-tax claims, and up to seven years for tax-related claims. Having made a notification, a buyer will then be given anything up to 12 months to actually formally commence proceedings after which it will lose its right to bring the claim.

Although emphasis is understandably placed on negotiating the relevant time periods themselves, the recent case of Dodika Limited & Others v. United Luck Group Holdings Limited [2020] EWHC 2101] highlights the importance of complying with all other notification requirements set out in the share purchase agreement in order to ensure that a claim is not prejudiced.

In this case, the buyer served the sellers with notice of a claim under the tax covenant with a view to retaining $50 million which had been placed in escrow.

The share purchase agreement required a notice of claim to “state in reasonable detail the matter which gives rise to such Claim, the nature of such Claim and (so far as reasonably practical) the amount claimed in respect thereof…”

The sellers claimed that although the notice referred to the existence of a tax investigation, it did not provide any detail of the underlying facts, events and circumstances giving rise to the claim, and particularly how these triggered a claim under the tax covenant, which meant that it was not a valid notice for the purposes of the share purchase agreement. The buyer on the other hand argued that this was irrelevant because the sellers were already fully aware of the underlying facts and circumstances, as they had actually been involved in responding to the tax investigations.

The High Court held that the notice was not compliant with the requirements of the share purchase agreement and the sellers’ knowledge could not be used to “remedy” this defect. The issue in question was not whether the sellers understood the claim and the matters giving rise to it – it was whether the procedural requirements of the share purchase agreement had been satisfied, which they had not. The notice of claim given by the buyer to the sellers was not valid and the buyer was out of time to bring the claim.

Although some may view this as a somewhat harsh judgement, it serves to remind parties that care must be taken to comply fully with any contractual notification requirements. Although most parties will sensibly seek legal advice as to the exact form of any notice, it is important to check that the content is itself full and complete.

An ill-judged decision to be overly concise can have expensive consequences.

Christine Dubignon is a Partner in the Corporate team.

Disclaimer

This note reflects our opinion and views as of 13 October 2020 and is a general summary of the legal position in England and Wales. It does not constitute legal advice.

Anti-Money Laundering Rules: Impact on the Art Market

• 5 October 2020
• News

The EU Fifth Anti-Money Laundering Directive (5AMLD) was enacted into UK law with effect from 10 January 2020. It requires art businesses to put in place systems intended to prevent their potential use in money laundering or for various other offences (in addition to those systems already required under the Proceeds of Crime Act 2002).

The rules apply to those trading, storing or acting as intermediaries in works of art (as defined in the VAT Act 1994), where the value involved is more than €10,000 (either for a single work of art or as part of a series of transactions). This is a significant extension to the existing rules, both in terms of those that are being made subject to additional regulation and the level of compliance required.

Those affected will be expected to register with HMRC. Senior management and beneficial owners will be subject to approval as part of this process. The deadline for registration was originally 10 January 2021, but it has now been proposed that this be extended to 10 June 2021 (although the other requirements are already in force).

The penalties for non-compliance are significant and senior management may be personally liable. Breaches may incur a maximum sentence of up to two years imprisonment.

Affected businesses should have implemented systems and checks to address the new rules. This is potentially difficult for an industry that has emphasised discretion and whose clients may be unused to the level of due diligence information required.

Practical impact of 5AMLD on the art sector

Given the high values involved, the portability of works, the clandestine nature of the market, and of course the lack of regulation to date, it is not difficult to see why the art market has historically been vulnerable to money laundering. Many therefore consider this legislation to be long overdue, and view it as a belated (and welcome) application of normal regulatory standards to the art world.

1) Who is affected?

As discussed briefly above, this legislation applies to any firm or sole practitioner that “by way of business trades in, or acts as an intermediary in the sale or purchase of, works of art” or who “is the operator of a free port when it, or any other firm or sole practitioner, by way of business stores works of art in the free port”. It therefore applies to agents, auction houses, galleries, dealers, warehouses, and any other individual or firm involved in the buying, selling or storing of art.

This wide definition, together with the low threshold of applicability (i.e. €10,000), means that the majority (if not all) of those operating in the art world have been (or will be) in some way affected by the new rules.

2) What do they need to do?

Those caught by the new regulatory framework will need to take a number of steps, including:

• Carrying out an internal risk assessment (including understanding the rationale for complex transactions, which will ultimately involve a level of judgment).
• Creating an anti-money laundering (AML) policy (which must cover a list of specified criteria and should be relevant and proportionate to the business in question).
• Carrying out client due diligence (CDD) both at the outset and on an ongoing basis (see below).
• Maintaining appropriate records in line with the above.
• Registering with HMRC.
• Training staff (with such training being appropriate to the staff in question and training records being maintained).
• Appointing a nominated officer to make reports to the National Crime Agency (there are also increased responsibilities for senior management).
• Reporting suspicious transactions.

CDD requires clients (including beneficial owners) to be identified, their identities verified with independent documents, this information documented and records kept. The source of funds and the transaction as a whole must also be understood.

For some businesses, the new rules merely formalise practices already in place (many already carry out due diligence, e.g. for provenance and title purposes). However, for others (particularly smaller entities dealing in high volumes), the measures that need to be taken are burdensome and expensive. It is worth noting in this regard that the legislation applies to businesses regardless of their size, and that the penalties for non-compliance are severe (see above).

Although regulated entities are expected to have started taking steps to comply with the new rules, they have been given a “grace period” for registration. This was initially one year, to 10 January 2021, and it appears likely that it will be extended to 10 June 2021. A spokesperson for HM Treasury said that the proposed extension is intended to “mitigate the risks of an application backlog due to Covid-19 pressures on HMRC’s and businesses’ resources”. In part, this may be an acknowledgment that the burden being placed on newly regulated entities may be heavy in some circumstances, particularly in view of the fact that for many, resources are greatly reduced due to the impact of the COVID-19 pandemic.

Collectors tend to be familiar with AML procedures (not least because they are a prerequisite to legal and other types of professional advice). Whilst for many, the new measures are probably little more than an inconvenience (in view of delays to transactions), for some, the new rules give rise to confidentiality issues and threaten to damage longstanding relationships by injecting a feeling of mistrust.

3) What other practical issues arise?

In terms of the legislation’s applicability, the term “intermediary” can be interpreted widely. For example, does this cover someone who introduces parties to a transaction but does not receive any commission?

Since regulated entities need to carry out CDD on ultimate clients, in the first instance, they need to consider who are the ultimate clients. In the context of the art world, this is not necessarily straightforward.

For example, where regulated dealers sell works via an agent, they will be required to carry out CDD on both the agent and the ultimate buyer. Agents are understandably reluctant to disclose the identities of their principal (since this risks them being sidestepped and losing their fee). The alternative is for the dealer to trust that the agents have carried out satisfactory CDD on the ultimate buyer, which is obviously not without risk: the British Art Market Federation (BAMF) guidance reminds regulated entities that, whilst they are permitted to rely on CDD carried out by other regulated entities, the party “conducting the sale retains responsibility, and is liable for any failure to comply with CDD obligations”. This therefore puts regulated agents and dealers in a difficult position.

Compliance with these rules at art fairs may be difficult on the basis of the high volume of impulse purchases and the fact that CDD generally has to be completed before transactions are finalised. Although it is possible for transactions to be agreed subject to CDD, works cannot be released until the relevant AML procedures have been completed. Whilst unfortunately most of 2020’s art fairs have fallen victim to the pandemic, these appear to be returning cautiously (Berlin Art Fair took over venues including Berlin airport and the Berghain earlier this month) and UK dealers will therefore need to turn their minds to this issue.

The widespread impact and practical issues discussed above have led some to question whether the new rules will push transactions to more favourable jurisdictions and could risk London losing its place as one of the global art market’s leading international hubs. However, given that 5AMLD applies across the EU, the UK is not alone in tightening regulation of the art market. Further, following a recent report by a US Senate Sub-committee describing the international art market as “the largest, legal unregulated industry in the United States”, many are expecting renewed pressure to be placed on Congress to pass AML legislation targeting the art sector.

4) How will the legislation be implemented?

There have been complaints about the clarity of the drafting and the lack of detailed guidance accompanying the legislation. Since the consequences of misunderstanding the rules are severe and can lead to registration being refused (in which case regulated entities will be prevented from transacting), clear rules are essential.

There is, however, an appeals process where registration has been refused. Further, the BAMF Guidance clarifies that regulated entities will be allowed to proceed with any transactions within the scope of the regulations whilst they are awaiting confirmation that their registration has been approved (provided they are meeting all their other obligations under the new rules). Although this is expressed in the context of the January 2021 deadline for registration, we can expect this to apply similarly if the proposed extension is passed into law.

It is unclear whether HMRC will show any leniency following the registration deadline to enable interpretation and other issues to be resolved. For example, will HMRC take a more sympathetic approach to small businesses for which the costs and complexity of introducing the measures are proportionately greater than for larger businesses, particularly in view of the financial impact of the pandemic?

5) What next?

It is not surprising that the art world is now subject to similar regulatory standards as other sectors. Notwithstanding this, the drastic widening of the regulatory net has not been met with universal applause.

In the short term, we hope to see more detailed guidance and (assuming registration is extended as proposed) HMRC taking a more sympathetic approach to non-compliance during the period following 10 June 2021. In the long term, it will be interesting to see how the art market reacts and whether this legislation will cause there to be a cultural shift in an industry which is notorious for its lack of transparency and regulation. The BAMF guidance notes that “[w]hile confidentiality and discretion will continue to be a feature of the art market, the changes introduced by the new regulations may in some cases result in a degree of increased transparency between art market participants.”

Given the economic downturn currently facing the UK, the Government will be considering how to balance the need to recoup the funds that have been spent as a result of the pandemic against the need to avoid over-taxation in order to encourage spending. As such, the wealth lodged in the international art market may be a politically attractive target.

If you have any art-related questions prompted by this note or otherwise, please do get in touch with the authors or your usual Forsters contact.

Robert Payne is a Senior Associate in the Private Client team, and Rebecca Welman is an Associate in the Dispute Resolution team.